Social Security: 2 Keys to Getting It Right

It's hard to make smart decisions about Social Security benefits, but here are some tips to make it easier.

Dan Caplinger
Dan Caplinger
Apr 30, 2014 at 2:15PM
Investment Planning

Millions of Americans face a major retirement crisis, having saved little toward their own retirement. As a result, Social Security will play an essential role in their retirement income planning.

But it can be extremely difficult to make the most of the Social Security benefits you're entitled to receive, because the choices you make can affect not only your own finances, but also those of your loved ones. Let's take a look at why Social Security has become so important and what you need to do to maximize it.

How Social Security became a necessity
Social Security was originally meant to provide supplemental income for retirees, rather than being a primary source of retirement income. Before Social Security, people got by with a combination of savings and the retirement income that some received from employer pensions.

Yet Social Security has become a huge part of financial security for retirees. One study from the Economic Policy Institute found that Social Security made up the majority of income for about 60% of Americans over the age of 65. In that group, poor and lower-middle-class people in retirement got around 80% of their income from Social Security, and even among middle- and upper-middle-class retirees, the proportion of retirement income from Social Security averaged out to roughly half.

Only the richest fifth of the retiree population can count on pensions and investment income for a bigger share of their cash needs than Social Security. Moreover, many upper-class people work beyond retirement age, adding to outside earnings.

So how can you make the right Social Security decisions? Consider the following two ideas.

1. When you file for benefits matters -- and not just to you.
Social Security benefits aren't all that complicated at first glance. What you have the most control over is when to start taking benefits. Start at the full retirement age of 66, and you'll get an amount based on your work history. Start early at age 62, and you'll get 25% less per month. Start later at age 70, and you'll get 32% more.

But nobody knows how long they'll live, and that's what makes the best decision so hard to figure out. Waiting until age 70 gets you the biggest monthly benefit, but missing out on four to eight years of payments might have you playing catch-up for a decade or more.

Moreover, Social Security decisions don't affect just you. If you're married, then your spouse's potential benefits are affected by your decision. The same is true of ex-spouses if you were married for 10 years or more and the ex-spouse never remarried. Moreover, if both you and your spouse have had careers, the interplay between your own benefits and spousal benefits, which are based on the other spouse's earnings history, is hard to analyze.

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Before you take benefits, consider the impact on everyone involved. In some cases, that will lead you to make a different decision than you would make if you were only considering yourself.

2. Do you need more monthly income?
There's a huge income gap between what most people need for retirement expenses and what Social Security provides. As a result, many insurance companies have come up with products like immediate annuities to turn lump sums into steady monthly income that can last the rest of your life. This makes immediate annuities look a lot like Social Security, complete with options like survivors' benefits and other ways to help you make your savings last as long as you live.

The problem, though, is that what you receive in income from immediate annuities relies on interest rates, and with rates having been extremely low, it takes a lot of money in a lump sum to buy an immediate annuity that pays a given amount. Moreover, many retirees aren't comfortable with the fact that with many immediate annuities, you can't change your mind later if you need that lump sum of money back for unanticipated big-ticket expenses. Even if your insurance company does provide a cash-out option for an immediate annuity, you'll often have to pay a significant penalty. Therefore you'd probably prefer to keep some money in reserve for major costs, rather than spending it all on an immediate annuity.

Be smart about Social Security
Deciding when to take Social Security benefits isn't something you should guess about. Instead, take the time to understand Social Security and figure out when you'll be best off getting benefits. The right answer will make retirement a lot more comfortable for you and your family.