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The Three Biggest Social Security Misconceptions

Many people’s mental model of Social Security spousal/survivor benefits works like this:

  1. Your spousal benefit is equal to half of your spouse’s retirement benefit.
  2. Your survivor benefit is equal to the amount your spouse was receiving as a retirement benefit prior to his/her death.
  3. If you file for a spousal benefit and a retirement benefit (or a survivor benefit and a retirement benefit), you get the greater of the two amounts.

Unfortunately, all three of those statements are wrong. They’re close enough, if you’re far from Social Security filing age and you just want a rough understanding of the system. But if you’re trying to do any planning with actual math, or if you’re trying to interact with the SSA, you need a more accurate understanding.

Let’s start with #3, because it is in my opinion the “wrongest.”

Here’s how it actually works: if you are entitled to (i.e., have already filed for) a retirement benefit of your own, and you then become eligible for (and file for) a spousal or survivor benefit, you continue to receive your own retirement benefit and you receive a spousal/survivor benefit in addition to that retirement benefit. If that sounds wrong or surprising to you, it’s because you have a misunderstanding about how spousal or survivor benefits are calculated.

How is a Spousal Benefit Calculated?

Your spousal benefit is initially calculated as half of your spouse’s primary insurance amount (PIA). A person’s primary insurance amount is the monthly retirement benefit they would get if they filed exactly at full retirement age.

Note that your spousal benefit is not half of your spouse’s monthly retirement benefit. It’s half of their PIA. If your spouse files for their own retirement benefit before or after their full retirement age, they would receive a retirement benefit that is more or less than their PIA. But your spousal benefit is still half of their PIA, not half of what they’re actually getting.

Then, after that initial calculation, your spousal benefit can be reduced for a whole bunch of different things.

Firstly, if you are also receiving your own retirement benefit, your spousal benefit gets reduced by the greater of your own retirement benefit or your own PIA.

Second, if you file for your spousal benefit before your full retirement age, your spousal benefit will be reduced for early filing.

And then that spousal benefit could also be reduced by various other rules (e.g., the government pension offset if you have a government pension, the family maximum rules if a child is also receiving benefits on your spouse’s work record, or the earnings test if you or your spouse are younger than full retirement age and still working).

Example: Sandra’s PIA is $2,000. Her husband Mark’s PIA is $600. Mark files for his retirement benefit four years prior to his full retirement age, so he gets a retirement benefit equal to 75% of his PIA, or $450. Later, after Mark reaches his FRA, he becomes entitled to a spousal benefit as well (because Sandra has filed for her own retirement benefit).

Mark’s spousal benefit is calculated as half of Sandra’s PIA, minus the greater of his own PIA or his own retirement benefit. That is, $1,000 – $600 = $400.

So his total monthly benefit is $450 + $400 = $850.

A few big takeaways here:

  • He receives a retirement benefit and a spousal benefit.
  • His retirement benefit is still reduced for having filed early.
  • His spousal benefit is not half of Sandra’s retirement benefit.
  • His total monthly benefit is $150 less than half of Sandra’s PIA. That’s because he’s still receiving his retirement benefit, and that retirement benefit is still reduced by $150 due to early filing.

If Mark’s spousal benefit had begun prior to his full retirement age, it would have to be multiplied by the applicable reduction factor for early entitlement. For example if his spousal benefit also began four years prior to his FRA, it would be multiplied by 70%. So it would be ($1,000 – $600) * 0.7 = $280.

How is a Survivor Benefit Calculated?

If your spouse had filed for his/her own retirement benefit by the time he/she died, then your survivor benefit is initially calculated as the greater of:

  • The amount your deceased spouse was receiving at the time of his/her death, or
  • 82.5% of your deceased spouse’s PIA.

If your spouse had not filed yet for his/her own retirement benefit by the time he/she died, then your survivor benefit is initially calculated as:

  • Your deceased spouse’s PIA, if your spouse died prior to his/her full retirement age, or
  • The amount he/she would have received as a retirement benefit if he/she had filed on his/her date of death, if your spouse died after reaching his/her full retirement age.

And from that point, some reductions can apply.

Firstly, if you are also entitled to your own retirement benefit, your survivor benefit is reduced by the amount of your own retirement benefit. (Note that this is different than with a spousal benefit, where it’s reduced by the greater of your own retirement benefit or your own PIA.)

Next, if your benefit as a surviving spouse begins prior to FRA, it has to be multiplied by an applicable reduction factor (details here).

And again, various other reductions might be applicable (e.g., government pension offset, earnings test, family maximum).

Why Does This Matter?

Things that reduce your benefit as a spouse or survivor (e.g., government pension offset, family maximum, or earnings test when it is your spouse who has excess earnings) do not reduce your own retirement benefit. So it’s important to know what portion of your total monthly benefit is a retirement benefit and what portion is a spousal/survivor benefit. If you think that you “get the greater of the two amounts” you would think that your whole benefit is a spousal/survivor benefit and the whole thing would be subject to reduction. But that’s not the case.

It’s also important when interacting with the SSA. SSA employees are tasked with implementing and explaining a very complex system of rules, so yes, mistakes do sometimes happen. But in the overwhelming majority of cases in which I hear that the SSA has provided incorrect information, it turns out that the SSA employee provided information that was precisely correct — though insufficiently explained — and that correct information collided with a preexisting misconception in the person’s mind (usually one of the three above), and the person ends up hearing something different than what the SSA employee actually said. It’s like a Who’s On First scenario, though not so funny when there are actual consequences.

You can easily imagine how something like that can happen. Just take Mark from our example above. He’s currently receiving a retirement benefit of $450. And, before Sandra files for her retirement benefit, he calls the SSA to ask for details about his spousal benefit. And imagine that Mark has previously heard that 1) a spousal benefit is equal to half of your spouse’s benefit and 2) you get a spousal benefit or your own retirement benefit. So he’s anticipating a spousal benefit of something like $800-$1,000.

SSA employee: Your spousal benefit will be $400 per month.
Mark: Wait, what? It’s only $400 per month? I thought it was going to be more than that.
SSA: No, I’m sorry. It’s $400 per month.
Mark (now worried that not only is his benefit not going to increase, but it might even decrease from $450 to $400): Well can I just choose not to file for it then?
SSA: No, you will automatically be deemed to have filed for your benefit as a spouse as soon as Sandra files for her retirement benefit.

Everything the SSA employee said was correct. But they didn’t catch on to the underlying misconceptions that Mark has. So now Mark is freaking out because he had been anticipating a benefit increase, and he thinks he has just been told that his benefit is about to go down and there’s nothing he can do about it. But in reality, he will be getting a benefit increase. He’ll keep getting his $450 retirement benefit, plus the $400 spousal benefit.

Many experienced SSA employees are well versed in these misconceptions, and they’re skilled at noticing when a miscommunication is occurring and then guiding the applicant toward a proper understanding. But that doesn’t always happen. It’s important to understand the rules for yourself.

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Investing Blog Roundup: Investing and Life Lessons from Taylor Larimore

Anybody who spends time on the Bogleheads forum quickly becomes aware of the contributions made by Taylor Larimore. In addition to being one of the authors of the Bogleheads Guide to Investing, he’s one of the most prolific members on the forum, with thousands of posts answering people’s nuts and bolts questions about investing.

This week I really enjoyed seeing Taylor get some mainstream-media recognition.

Recommended Reading

Thanks for reading!

Do You Need a Financial Planner?

A common refrain in the realm of DIY personal finance is that by the time you know enough about investing to be able to pick the right type of advisor, you likely don’t need an advisor.

If we’re only talking about investing, I think that’s true. The more you learn about investing, the more you realize that a very simple approach (i.e., a portfolio with a few low-cost index funds or ETFs) is quite possibly the best approach. Or, if it isn’t the best approach, it’s at least close.

And no, you probably don’t need professional help to manage a simple index fund portfolio, especially if you’re still in your “accumulation” stage. (Though even then, a person might still choose to delegate such responsibilities.)

The financial planning industry grew out of the stock brokerage industry, so many people still think of financial planners as “people who give investment advice.” But investing is only one piece of personal financial planning. And, frankly, it’s the easiest piece.

Insurance planning can be complicated. With life insurance, simpler is generally better. But there’s plenty of complexity involved with choosing a health or disability policy. And if you already own a deferred variable annuity and you’re trying to figure out what to do with it, there’s nothing simple about that decision. Professional assistance may be valuable.

And then you’ve got tax planning. I’ve worked in the tax field for ~15 years, and I’m still regularly learning about a new tax law, learning about some state tax law that I haven’t had to know about before, re-learning about an existing law that I haven’t had to deal with recently, or learning about the interaction of two pieces of tax law.* It’s complicated. And the more I learn, the more I realize the depth and breadth of what I still don’t know.

Estate planning is similar. For some people, it’s not so bad — get your basic documents in order, and you’re all set. For other people (e.g., combined families, or people trying to provide for a disabled loved one after their own death) it can get complicated in a hurry. Guidance from an experienced estate planning attorney (e.g., Bruce Steiner) or a financial planner who deals with estate-related topics (e.g., Elliott Appel) could provide a better financial outcome as well as considerable peace of mind.

With regard to student loans, the rules for public service loan forgiveness can be bewildering. If that’s a path that could be available for you, advice from somebody like Ryan Frailich who deeply knows those rules could be extremely valuable.

Running a simple portfolio is indeed simple. But financial planning involves a lot more than just running a portfolio. In fact, it involves so much more that there’s no way for one person to be an expert in all of it — even if it’s their full-time job and they have decades of experience. If/when one of those more complicated situations becomes relevant to your household, requesting professional assistance isn’t some sort of failure. It’s a prudent decision, to minimize the likelihood of a mistake undoing the smart decisions you’ve already made.

*Among tax professionals, the words “quick question” (or “simple return”) are self-contained jokes/punchlines. Almost everybody thinks they have a quick question. What makes things complicated isn’t so much any one particular provision in the law (unless it’s the QBI deduction). What makes things complicated is the interactions between multiple provisions. There are many tax topics/situations that are individually very common (e.g., dealing with a particular deduction or credit, the sale of a home, sale of a business, the way long-term capital gains and qualified dividends are taxed, etc.). But each household has a handful of different things from that menu that happen to be applicable to them. And the possible combinations are endless. So even if a tax professional has worked with each of these individual topics many times, this may well be the first time he or she has dealt with this specific combination and the ramifications thereof.

Investing Blog Roundup and A Favor Request (Social Security Made Simple)

A favor request: When the 2022 edition of Social Security Made Simple went up on Amazon (print version here and Kindle version here), the reviews from prior editions did not carry over. If you have read the book and have a moment, I’d sincerely appreciate it if you could post a short review of what you thought.

Other Recommended Reading

Thanks for reading!

Accounting for Illiquid/Intangible Assets on Your Household Balance Sheet

A reader writes in, asking:

“What do you think about including the present value of human capital, social security, pensions, etc when calculating your asset allocation? I have read about doing so in various sources over the years, but it strikes me as the sort of thing that makes sense in an academic world but causes problems if actually attempted in real life.”

I’ve written about this before with regard to Social Security, but my thoughts are similar regarding other such assets (and liabilities).

Human capital: it’s not a stock. It’s not a bond. But it is a very real asset (unless of course you’re permanently retired/disabled).

Social Security: it’s not a stock. It’s not a bond. But it is a very real asset.

Your home, if you own one: it’s not a stock. It’s not a bond. But it is a very real asset.

Future consumption: it’s not a stock (or a negative stock). It’s not bond (or a negative bond). But it is a very real liability.

Point being, yes, you should be thinking about all of those things when you make financial planning decisions. But I don’t think it makes a lot of sense to try to lump them into categories in which they don’t really belong.

But what does it mean to be thinking about these things when making financial planning decisions?

Let’s go through some examples.

An asset allocation that’s appropriate for somebody with a safe job in a safe field (e.g., a tenured professor) may not appropriate for somebody with a very risky job in a very risky field (e.g., a sales position for a start-up), even if everything else about the two people is exactly identical.

That doesn’t mean that we should calculate the present value of each person’s human capital, assign that human capital a stock/bond rating (e.g., “Sarah’s human capital is 30% stock, 70% bond”), and then rebalance accordingly every year. Because doing that can lead to all sorts of wacky decisions. For example, such an approach could require a 25-year old to shift her 401(k) allocation wildly back and forth from one year to the next, because her financial assets are a very small figure relative to her human capital, so any changes in the human capital could require massive changes to the allocation of the financial assets.

But yes, if you have a riskier job, you should probably have a safer portfolio. And it’s really not a good idea to fill your financial portfolio with assets that would be highly correlated to your human capital. For example, if you work in the tech sector, you probably don’t want to have tech stocks dramatically overweighted in your portfolio. And it’s really, really not a good idea to have a big part of your portfolio invested in your employer’s stock.

As far as Social Security and pension income, if your spending needs are completely (or mostly) met by such safe sources of income, then you can afford to take on more risk in your portfolio than if your guaranteed income sources were very small relative to your spending needs. But that doesn’t mean that you need to be regularly recalculating the expected present value of your pension assets and including that figure in the math every time you rebalance your portfolio.

Or, consider two retirees whose circumstances are exactly identical, except that one owns her home and the other rents. The homeowner is meaningfully less exposed to inflation risk, and that could inform the asset allocation decision. In addition, that home is a chunk of wealth that could be turned into spending if necessary (e.g., via a reverse mortgage). And that likely means that the homeowner can safely spend a greater dollar amount per year than the renter. But again, that doesn’t mean that we should pretend the home is some sort of stock/bond hybrid and include that in the portfolio rebalancing math.

Investing Blog Roundup: Active Share, Not a Great Bet

There is, at this point, roughly half a century of evidence showing that actively managed funds generally underperform their lower-cost passively managed counterparts. (And then there’s William Sharpe’s classic piece The Arithmetic of Active Management which succinctly demonstrates that the average actively managed dollar by definition will underperform the average passively managed dollar, assuming active management means higher costs.)

But back in 2009 two researchers found that there might be a way to pick those actively managed funds that will outperform: by selecting based on “active share” (essentially, how different are this fund’s holdings relative to those of its benchmark).

Sadly, that finding hasn’t really held up well. At all.

Other Recommended Reading

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