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How Important is Social Security Planning?

A reader writes in, asking:

“Just how important is it to learn about all the ins and outs of social security? When I look at the benefit estimates on my statement, they aren’t exactly small amounts, but this doesn’t look like it’s going to be the most important financial decision I’ve made in my life. And yet people go back and forth forever (eg on bogleheads) about whether filing at 62, 66, 70, or whatever is best.”

In terms of expected spending (in today’s dollars) over the course of a retirement, the difference between the ideal Social Security filing strategy and a very bad strategy is often in the $20,000-$40,000 range for a single person. For a married couple, the difference between the ideal strategy and a very bad strategy would often be in the $50,000-$100,000 range.*

The difference between the ideal strategy and a fairly similar strategy is much smaller. For instance if filing at 70 is ideal for you, filing at 69 and 6 months is likely to have a very similar result — a few thousand dollar difference over the course of your retirement.

So even if we’re comparing a good strategy to a very bad strategy, no, it’s not even close to the most important financial decision you’ll ever make. The career you pick, the city/cities you choose to live in, the home(s) you buy or don’t buy, the job(s) you take, whether you get married/divorced/have kids — all of those things will have a larger impact on your finances over your lifetime than your Social Security claiming decision(s).

But, for most people, you can learn most of what you need to know about Social Security from just a handful of hours of reading (in addition to my book Social Security Made Simple, I can also enthusiastically recommend Andy Landis’s Social Security: The Inside Story or Jim Blankenship’s Social Security Owner’s Manual). And if a few hours of self-education can provide a mid-five-figure expected return, those are some well-spent hours.

A key point here is that if you are not a financial planner (i.e., you are not trying to become an expert in all of the situations your clients might face), you only need to learn about the parts that apply to you. You can (probably) ignore most of the complexity. For example:

  • If you don’t have minor children or adult disabled children, you can ignore everything about child benefits and the family maximum.
  • If you don’t have a pension from non-covered employment, you can ignore everything about the windfall elimination provision and government pension offset.
  • If you have never married (or if you were married less than 10 years prior to a divorce), you can ignore everything about spousal/survivor benefits.
  • If you are married and you and your spouse were both born after 1/1/1954, you can ignore everything about restricted applications.

Most unmarried people and married couples have either one or zero complicating factors. A basic cookie-cutter-type plan works reasonably well for most people.

Social Security planning is primarily about avoiding a particularly bad strategy, and that mostly means:

  • Don’t miss a restricted application if you have the chance.
  • Get within a year or so of your ideal filing age. (For example if age 70 is the mathematically ideal age for your circumstances, don’t file at 62 or 63. But don’t worry too much about the difference between 69 and 70.)

*The differences are often greater when we also account for tax planning. Also, delaying has a risk-reduction effect that isn’t reflected in these numerical differences.

Want to Learn More about Social Security? Pick Up a Copy of My Book:

Social Security cover Social Security Made Simple: Social Security Retirement Benefits and Related Planning Topics Explained in 100 Pages or Less
Topics Covered in the Book:
  • How retirement benefits, spousal benefits, and widow(er) benefits are calculated,
  • How to decide the best age to claim your benefit,
  • How Social Security benefits are taxed and how that affects tax planning,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"An excellent review of various facts and decision-making components associated with the Social Security benefits. The book provides a lot of very useful information within small space."

Social Security: It Is an Asset, But Not a Bond

A reader writes in, asking:

“At our local Bogleheads chapter meeting, there was a heated discussion about Social Security, specifically, whether it should be counted as a bond in your asset allocation. My view is that it’s not really an asset because you can’t sell it. But one of the more experienced people in our group was emphatic that it’s a mistake to leave Social Security out of an asset allocation analysis and that it should be counted as a bond because it provides predictable payments.”

This question comes up over and over, year after year — both in my email inbox as well as on the Bogleheads forum.

Social Security is an asset. It’s true that it is not a liquid asset (i.e., you cannot sell it). But even illiquid assets show up on balance sheets. Same goes for lifetime annuities. They are assets, even if they are not liquid.

And yes, Social Security is a fixed-income asset. So it’s more bond-like than stock-like.

But it’s definitely not a bond.

There are a lot of differences between a) having a $2,000 monthly Social Security benefit at full retirement age (i.e., a stream of income with a present value of about $350,000) and b) having $350,000 of bonds in your brokerage account.

Social Security is what it is — and it isn’t what it isn’t.

The desire to classify everything as either a stock or a bond is completely bananas.

For example, do you classify your house as a stock, because its value goes up and down considerably over time? Or do you classify it as a bond, because it pays you “interest” in the sense that you do not have to pay rent each month? (I hope the answer is obvious: it’s neither a stock nor a bond, because it is a house.)

The distinctions between different types of assets are real and useful.

Social Security:

  • Is inflation-adjusted,
  • Will last your entire lifetime,
  • Will not extend beyond your lifetime (or beyond you and your spouse’s lifetimes if married, child benefits notwithstanding),
  • Is absolutely illiquid (i.e., it’s not just hard to sell; it cannot be sold at all), and
  • Is subject to political risk.

By shoehorning that into the “bond” category, you are ignoring some or all of those unique characteristics. You are ignoring useful information.

Relatedly, if you have decided, for example, that you want 40% of your portfolio in bonds, but you haven’t yet decided what will count as a bond, how did you decide that 40% was the right number? Perhaps the line of reasoning that went into that decision had some flaws.

Rather than counting Social Security income as part of your bond allocation, I’d suggest using this method for fitting it into your overall retirement plan:

  1. Determine how much money you plan to spend each year during retirement.
  2. From that, subtract any part-time job or business income you expect to earn.
  3. From the remaining amount, subtract your Social Security/pension income to determine how much you will need to spend from your portfolio each year.
  4. Then make any portfolio-related decisions (including asset allocation) with that net required-spending-from-portfolio figure in mind.

Want to Learn More about Social Security? Pick Up a Copy of My Book:

Social Security cover Social Security Made Simple: Social Security Retirement Benefits and Related Planning Topics Explained in 100 Pages or Less
Topics Covered in the Book:
  • How retirement benefits, spousal benefits, and widow(er) benefits are calculated,
  • How to decide the best age to claim your benefit,
  • How Social Security benefits are taxed and how that affects tax planning,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"An excellent review of various facts and decision-making components associated with the Social Security benefits. The book provides a lot of very useful information within small space."

Social Security with Foreign Work History: Totalization Agreements

Last week I was a guest on Rick Ferri’s Bogleheads on Investing podcast. You can listen to that podcast here. (The Bogleheads discussion thread is here, if you want to post any comments.)

One question that a few Bogleheads had asked was about how a US citizen can qualify for U.S. Social Security benefits if they were covered under a foreign social security system for a portion of their working career.

I gave a very brief answer on the podcast, but I wanted to discuss that topic more thoroughly here.

In short, how exactly it plays out depends on which other country you worked in. The U.S. has “totalization agreements” with many countries that provide the rules for how a worker will be treated, but the exact details vary from one agreement to another. (There’s no way around such a situation, given that each country has its own unique tax and social security systems.)

And, unfortunately, given that the specifics vary for each of the agreements, it’s unlikely that you’ll find anybody who is a true expert on any one of them. (I most definitely am not. Despite dealing with Social Security topics all the time, it would be rare for me to get even two people asking about the same totalization agreement in a given year.)

Generally speaking, however, the effects of the totalization agreements are to:

  1. Eliminate dual taxation that would otherwise occur (i.e., simultaneously paying into two countries’ social security systems), and
  2. Allow you to qualify for benefits when you might not otherwise qualify.

Qualifying for Benefits (“Totalization”)

If you meet all the basic requirements under one country’s system, you will get a regular benefit from that country.

If you have at least 6 credits (“quarters of coverage”) under the U.S. Social Security system, but you do not have the 40 credits that would ordinarily be necessary to qualify for a retirement benefit, your credits will be “totalized.” That is, your credits under the foreign social security system will be counted toward qualifying for U.S. Social Security.

And the opposite would happen as well — if you don’t quite qualify for coverage under the foreign social security system, totalization would allow your U.S. periods of coverage to be counted toward qualifying there.

Calculating Benefits

If you end up qualifying for U.S. Social Security benefits via totalization, there is a special set of rules for calculating the benefit. You can find the exact details here, but very roughly what’s going on is that:

  • Only your U.S. earnings are included in the calculation, and
  • The benefit that is calculated based on those U.S. earnings is ultimately multiplied by a fraction, which represents the portion of your career for which you were paying into the U.S. system.

Windfall Elimination Provision and Government Pension Offset

Usually, when you receive a pension from employment for which you did not pay U.S. Social Security taxes, the windfall elimination provision (WEP) applies, reducing your primary insurance amount. With regard to foreign social security benefits, however, the WEP will not apply if you are:

  • Entitled to a U.S. totalization benefit (i.e. you only qualified for a U.S. Social Security benefit by counting your credits from the foreign social security system), or
  • Entitled to a regular U.S. benefit, as well as a foreign benefit which is based on a totalization agreement with the U.S. (i.e. you only qualified for the foreign social security benefit via counting your U.S. credits), and you are not receiving any other pension based on non-covered work (e.g., a pension from the state of Illinois).

Finally, a foreign social security benefit will not trigger the government pension offset (GPO).

Want to Learn More about Social Security? Pick Up a Copy of My Book:

Social Security cover Social Security Made Simple: Social Security Retirement Benefits and Related Planning Topics Explained in 100 Pages or Less
Topics Covered in the Book:
  • How retirement benefits, spousal benefits, and widow(er) benefits are calculated,
  • How to decide the best age to claim your benefit,
  • How Social Security benefits are taxed and how that affects tax planning,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"An excellent review of various facts and decision-making components associated with the Social Security benefits. The book provides a lot of very useful information within small space."

Can You Trust Information from the SSA?

A reader writes in, asking:

“I’ve heard from a few different acquaintances that they received bad information or advice from the SSA. Is it really true that you can’t even trust information coming directly from the Social Security Administration?”

It’s true that SSA employees sometimes provide inaccurate information. SSA representatives are dealing with a complex set of rules regarding a broad range of topics. And they only get a limited amount of training before being put on the front line, answering people’s questions. Mistakes happen, despite best efforts and good intentions.

It’s also important to recognize that Social Security rules use very specific terminology. I have encountered many situations in which an SSA employee provided an answer that was 100% correct — but the person asking the question misunderstood the answer. I’ve also encountered numerous situations in which a person accidentally asks something other than what they meant to ask (e.g., they ask whether they are entitled to a benefit, when they really wanted to know whether they’re eligible for that benefit), and the SSA employee correctly answers the question asked. And, again, the net result is that the person comes away with a misunderstanding, even though the SSA employee provided a correct answer to the question that was asked.

The key takeaway here is that, if you want to be truly sure of something, you have to look at the official rules. I know that stinks, because they can be challenging to read. But before relying on something somebody tells you (whether that somebody is an SSA employee, me, or anybody else), try to find confirmation from an official source. Here are the three official sources to check, in order of authority (from highest to lowest):

A few points about the above sources:

  1. The Regulations have not been updated for the changes made by the Bipartisan Budget Budget Act of 2015. (If you need information relating to deemed filing or voluntary suspension, I would go to the POMS.)
  2. The POMS is by far the most thorough of the sources above. It does not, however, have any legal authority. So if, for example, something in the POMS contradicts something in the Act, the Act wins.
  3. Other than the three above sources, most pages on the SSA website are akin to IRS publications in that they’re intended to be plain-english explanations of the rules, but they may use imprecise language or omit exceptions that could be relevant to you.

Finally, let me offer two related tips about dealing with the SSA:

  1. Remember that SSA employees are not financial planners. They are not really trained for giving advice, because that’s not their job. Rather, they are essentially “order takers” whose job is to process the application that you file and to answer questions about what benefits you are/aren’t entitled to (or eligible for).
  2. When you apply for Social Security, apply online. In all the time I’ve been working with Social Security, I’ve only ever heard from one person whose online application was processed incorrectly. Conversely, I have heard from I have-no-idea-how-many people about their in-person or phone applications being processed incorrectly.

Want to Learn More about Social Security? Pick Up a Copy of My Book:

Social Security cover Social Security Made Simple: Social Security Retirement Benefits and Related Planning Topics Explained in 100 Pages or Less
Topics Covered in the Book:
  • How retirement benefits, spousal benefits, and widow(er) benefits are calculated,
  • How to decide the best age to claim your benefit,
  • How Social Security benefits are taxed and how that affects tax planning,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"An excellent review of various facts and decision-making components associated with the Social Security benefits. The book provides a lot of very useful information within small space."

Open Social Security Update: Child Benefits, Retroactive Applications

A few days ago I rolled out an update for the Open Social Security calculator that includes a few new pieces of functionality:

  • Child benefits (now for married couples as well as single people),
  • Child-in-care spousal benefits, and
  • Retroactive applications.

This update took about three months of work, mostly because the “combined family maximum” rules and child-in-care spousal benefit rules are pretty complicated. (And the calculator has to be prepared to deal with any combination of uncommon complicating factors.)

If you are using the child benefit-related functionality, please be aware that the calculator will take somewhat longer to run. When minor children or disabled children are in the picture, your computer has to do a lot more math in each month of the simulations.

With regard to child-in-care spousal benefits, I expect to do a more thorough writeup of how they work in the not-so-distant future. But for now, a simplified explanation is that they’re like regular spousal benefits, with a few major differences:

  • You don’t have to be age 62 to receive them,
  • There is no reduction for entitlement prior to full retirement age, and
  • Filing for (and entitlement to) child-in-care spousal benefits does not trigger a deemed filing for retirement benefits.

As far as retroactive applications, the calculator now recommends them when a person is eligible for such and when such would be helpful. A simplified explanation of the retroactive application rules is that a person beyond FRA can backdate their application up to 6 months (or 12 months in some disability-related cases) — but no earlier than the month in which they reached full retirement age.

Want to Learn More about Social Security? Pick Up a Copy of My Book:

Social Security cover Social Security Made Simple: Social Security Retirement Benefits and Related Planning Topics Explained in 100 Pages or Less
Topics Covered in the Book:
  • How retirement benefits, spousal benefits, and widow(er) benefits are calculated,
  • How to decide the best age to claim your benefit,
  • How Social Security benefits are taxed and how that affects tax planning,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"An excellent review of various facts and decision-making components associated with the Social Security benefits. The book provides a lot of very useful information within small space."

When Should I Take Social Security Benefits? (Single Investor)

The following is an excerpt from my book Social Security Made Simple: Social Security Retirement Benefits and Related Planning Topics Explained in 100 Pages or Less.

Even if you are married, the place to start when trying to figure out when to claim Social Security is with a solid understanding of the (less complicated) analysis for unmarried retirees.

And before we go any further, let’s make sure we’re on the same page about an important point: The decision of when to retire is separate from the decision of when to claim Social Security benefits. For example, depending on circumstances, you might find that it makes sense to retire at a given age, yet hold off on claiming Social Security until a later date — maybe even several years later.

The earlier you claim Social Security, the less you’ll receive per month. For example, the following table shows how retirement benefits are affected by the age at which you first claim them:

Age when you claim retirement benefits Amount of retirement benefit
5 years before FRA 70% of PIA
4 years before FRA 75% of PIA
3 years before FRA 80% of PIA
2 years before FRA 86.67% of PIA
1 year before FRA 93.33% of PIA
at FRA 100% of PIA
1 year after FRA 108% of PIA
2 years after FRA 116% of PIA
3 years after FRA 124% of PIA
4 years after FRA 132% of PIA

Background: Your “primary insurance amount” (PIA) is the amount you would receive per month if you claimed retirement benefits at your “full retirement age” (FRA).

In other words, by waiting until age 70 rather than claiming as early as possible at age 62, you can increase your monthly benefit amount by roughly three-quarters. Of course, by waiting, you decrease the number of months in which you’ll be receiving a Social Security check.

So how can you tell if the trade-off is worth it? One way to compare two possible ages for claiming benefits is to compute the age to which you would have to live for one strategy to become superior to the other strategy. Another way to analyze the decision is to compare the payout you get from delaying Social Security to the level of income you can safely get from other retirement income sources.

Computing the Breakeven Point

EXAMPLE: Alex and Bob are both retired and unmarried. Both are age 62, both have a full retirement age of 66 and 6 months, and both have exactly the same earnings history. In fact, the only difference between the two is that Alex claims his retirement benefit at age 62, while Bob waits all the way until 70. Even though Alex claims benefits at age 62, he doesn’t need to spend the money right now, so he keeps it in his savings account, where it earns a return that precisely matches inflation.

By age 70, because he has been receiving benefits for eight years, Alex is far better off than Bob. However, starting at age 70, Bob starts to catch up (because he’s receiving a monthly benefit equal to 128% of his primary insurance amount, as compared to Alex who is receiving a monthly benefit equal to 72.5% of his primary insurance amount).

In the end, Bob’s cumulative benefit surpasses Alex’s cumulative benefit halfway through age 80. From age 80.5 onward, Bob’s lead over Alex continues to grow.

The takeaway: For an unmarried retiree, from a breakeven perspective, if you live past age 80.5, you will have been better off claiming benefits at age 70 instead of claiming as early as possible at age 62.

According to the Social Security Administration, the average total life expectancy for a 62-year-old female is 84.9. For a male, it’s 82.1. In other words, from a breakeven perspective, most unmarried retirees will be best served by waiting to take their retirement benefit.

Comparing Social Security to Other Income Options

When you delay Social Security, you give up a certain amount of money right now (i.e., this month’s or this year’s benefits) in exchange for a stream of payments that will increase with inflation for the rest of your life.

Take, for example, somebody with a full retirement age of 66. If her benefit at full retirement age would be $1,000 per month, her benefit at age 62 would be $750 per month, and at age 63 it would be $800 per month.

Therefore, waiting from age 62 to age 63 is the equivalent of paying $9,000 (that is, $750 forgone per month, for 12 months) in exchange for a source of income that pays $600 per year (that is, a $50 increase in monthly retirement benefit, times 12 months per year), adjusted for inflation, for the rest of her life.

Dividing $600 by $9,000 shows us that delaying Social Security retirement benefits from age 62 to 63 provides a 6.67% payout. Let’s see how that compares to other sources of retirement income.

Inflation-adjusted single premium immediate lifetime annuities are essentially pensions that you can purchase from an insurance company. With such an annuity, you pay the insurance company an initial lump-sum (the premium for the policy), and they promise to pay you a certain amount of income, adjusted for inflation, for the rest of your life. In other words, such annuities are a source of income very similar to Social Security.

As of this writing, according to the website immediateannuities.com (which provides annuity quotes from multiple insurance companies), the highest payout available to a 63-year-old female on such an annuity is 4.04%. For a male, the highest available payout would be 4.33%. As you can see, both of these figures fall well short of the 6.67% payout that comes from delaying Social Security from 62 to 63.

Alternatively, we can compare the payout from delaying Social Security to the income that you can safely draw from a typical portfolio of stocks and bonds. Several studies have shown that, historically in the U.S., retirees trying to fund a 30-year retirement run a significant risk of running out of money when they use inflation-adjusted withdrawal rates greater than 4%. And it’s worth noting that even a 4% withdrawal rate isn’t a sure bet going forward, given that the studies show 4% to be mostly safe in the past, which is a far cry from completely safe in the future.

In other words, for each dollar of Social Security you give up now (by delaying benefits), you can expect to receive a greater level of income in the future than you could safely take from a dollar invested in a typical stock/bond portfolio.

A similar analysis can be performed for each year up to age 70, and the conclusion is the same: Delaying Social Security benefits can be an excellent way to increase the amount of income you can safely take from your portfolio.

EXAMPLE: Daniel is retired at 62 years old. His full retirement age is 66 and 6 months. He has $50,000 of annual expenses and a $600,000 portfolio. He is trying to decide between claiming benefits as early as possible at age 62 or spending down his portfolio while he holds off on claiming benefits until age 70.

Daniel’s primary insurance amount (the amount he’d receive per month if he claimed his retirement benefit at full retirement age) is $2,500, which means he would receive:

  • $1,812 per month ($21,744 per year) if he claimed benefits at age 62, or
  • $3,200 per month ($38,400 per year) if he claimed benefits at age 70.

If Daniel claims his retirement benefit at age 62, he’ll have to satisfy $28,256 of expenses every year from his portfolio (because Social Security will only be satisfying $21,744 out of $50,000). That is, he’ll be using a 4.71% withdrawal rate ($28,256 divided by his $600,000 portfolio) starting at age 62. That’s a higher withdrawal rate than most experts would recommend.

Alternatively, if Daniel delays Social Security until 70, he’ll have to satisfy annual expenses of $11,600 (i.e., $50,000, minus $38,400 in Social Security benefits), plus an additional $38,400 for each of the eight years until he claims Social Security.

If Daniel allocates $307,200 (that is, $38,400 x 8) of his $600,000 portfolio to cash or something else very low-risk (in order to satisfy the additional expenses for those eight years), that leaves him with a typical stock/bond portfolio of $292,800. With a portfolio of $292,800 Daniel can satisfy his remaining $111,600 of annual expenses using a withdrawal rate of just 3.96%.

In effect, Daniel is spending down a portion of his portfolio in order to purchase additional Social Security benefits in the amount of $16,656 per year, starting at age 70. By doing so, he’s reduced the withdrawal rate that he’ll need to use from his portfolio for the remainder of his life, thereby reducing the probability that he’ll run out of money. In addition, if Daniel’s portfolio performs very poorly and he does run out of money, he’ll be much better off in the wait-until-70 scenario than in the claim-at-62 scenario, because he’ll be left with $38,400 of Social Security per year rather than $21,744.

Reasons Not to Delay Social Security

Of course, there are circumstances in which it would not make sense for an unmarried person to delay taking Social Security.

First and most obviously, if your finances are such that you absolutely need the income right now, then you have little choice in the matter.

Second, if you have reason to think that your life expectancy is well below average, it may be advantageous to claim benefits early. For example, if you have a medical condition such that you don’t expect to make it past age 64, it would obviously not make a great deal of sense to choose to wait until age 70 to claim benefits.

Third, the higher market interest rates are, the less attractive it is to delay Social Security. For example, if inflation-adjusted interest rates (such as those on inflation-protected Treasury bonds known as TIPS) were 2-3% higher than they are as of this writing, the payout from inflation-adjusted lifetime annuities might be higher than the payout from delaying Social Security.

Simple Summary

  • For unmarried retirees, from a breakeven perspective, you’ll be best served by waiting until age 70 to claim benefits if you expect to live past age 80.5. (And, for reference, the average total life expectancy for a 62-year-old female is 84.9. For a male, it’s 82.1.)
  • For unmarried retirees, on a dollar-for-dollar basis, the lifetime income you gain from delaying Social Security is generally greater than the level of income you can safely get from other sources. As a result, delaying Social Security can be a great way to increase the amount you can safely spend per year. (Or, said differently, it can be a great way to reduce the likelihood that you will outlive your money.)
  • The shorter your life expectancy and the greater the available yield on inflation-protected bonds, the less desirable it is to delay claiming Social Security benefits.

Want to Learn More about Social Security? Pick Up a Copy of My Book:

Social Security cover Social Security Made Simple: Social Security Retirement Benefits and Related Planning Topics Explained in 100 Pages or Less
Topics Covered in the Book:
  • How retirement benefits, spousal benefits, and widow(er) benefits are calculated,
  • How to decide the best age to claim your benefit,
  • How Social Security benefits are taxed and how that affects tax planning,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"An excellent review of various facts and decision-making components associated with the Social Security benefits. The book provides a lot of very useful information within small space."
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My new Social Security calculator (beta): Open Social Security