Like it or not, Social Security is the most important financial resource for millions of Americans. With employer pensions becoming a thing of the past and most people having woefully little set aside for their own savings, making the most of Social Security will make or break a huge number of retirees both now and in the coming years.
What few realize, though, is just how many choices you have with Social Security benefits. The right choice can stretch your benefits a lot further, while common missteps can leave you with far less than you might have gotten if you'd done just a little extra homework. To make the best choice for you, it's critical to understand what's at stake.
The ins and outs of Social Security benefits
For a program with such a simple mission, Social Security is extremely complicated. For instance, even coming up with your baseline monthly payment is hard to do, as you have to take your 35 top-earning years and adjust them for inflation to come up with average earnings. From there, a progressively tailored formula determines your standard monthly benefit.
But that's only the starting point, because you also have flexibility in deciding when to start taking Social Security. At any point between age 62 and 70, you can claim your benefits. But the earlier you take them, the smaller your payments will be. The longer you wait, the more you'll get paid each month. That leaves you with a huge potential range for benefits, with monthly payments anywhere from a quarter less than your baseline benefit if you start at age 62 to a third more if you wait until age 70.
If you're married, benefits calculations get even more complex. That's because as a spouse, you have the right to take Social Security payments based either on your own salary history or on your spouse's salary history. Typically, you can get half of whatever your spouse is entitled to if you claim a spousal benefit. That opens the door to some intriguing strategies, but they require careful thought.
All in the family
In making decisions about your benefits, it's incredibly important to consider not just the immediate financial impact but also how it affects future payouts as well. Also, because the decisions you make can affect your spouse or other dependents if you have them, you have to take their finances into consideration in making the best choice you can for your entire family.
Among the available strategies are the following:
- For spouses who both have substantial earnings histories, having one spouse file for Social Security early lets both spouses claim benefits -- one based on his or her own benefit and the other based on a spousal benefit. Later, the second spouse can claim his or her own benefit, which should be higher because of the delay in claiming until a later age.
- In a one-income household, the working spouse can use what's called the "file and suspend" strategy, filing for benefits to establish a spousal benefit for the other spouse but immediately suspending payments for the working spouse's benefit. That allows the clock to keep running for the working spouse, leading to higher monthly payments at whatever later age the working spouse chooses to start collecting them.
Of course, deferring benefits requires replacing that money with other income. Where can you get it? Until the past five years or so, retirees and near-retirees had been able to expect rates of 4% to 5% from Bank of America (NYSE: BAC ) , JPMorgan Chase (NYSE: JPM ) , and Citigroup (NYSE: C ) . Now, those institutions have prime rates below those levels, leaving savers with few opportunities to earn income.
Instead, retirees have turned to dividend stocks and funds. With iShares Dow Jones Dividend (NYSEMKT: DVY ) and Vanguard Dividend Appreciation (NYSEMKT: VIG ) offering better yields than banks can offer on CDs, you can go that route to get more income from your portfolio, leaving Social Security for later with a higher payout.
Don't penalize yourself
The other thing to remember is that if you're still working at age 62, don't expect to file for Social Security early and get a windfall. Social Security rules start taking away your early retirement benefit once your annual earnings go above around the $14,000 mark, reducing your payout by $1 for every $2 over the limit. Many workers may find that they'd get nothing by filing early as long as they keep working.
Of course, it's impossible to perfectly manage your Social Security benefits to get the absolute highest amount possible, given the uncertainties in life expectancy. But by keeping at least these basic ideas in mind, you can increase the chances of taking Social Security at the right time for you.
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Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance. You can follow him on Twitter @DanCaplinger.