The following is adapted from Spending Money and Having Fun.
It’s been said that “old age is not for sissies.” Aging makes a lot of demands on us. It’s humbling. And at one time, it reduced too many people to dependence upon charity. Those too old to work, if they lacked financial resources, sank quickly into poverty and relied on their children or the kindness of others. This was never more pronounced or true in this country than during the Great Depression.
As a response, in 1935, President Franklin D. Roosevelt proposed a program requiring people to prepare their own economic security through payroll deductions. It was a kind of enforced savings plan with an eye on the future. The 1935 Social Security Act changed forever the way we think of retirement support.
On January 31, 1940, the first monthly retirement check was issued to Ida May Fuller, age 65, a legal secretary from Ludlow, Vermont. She received $22.54. She lived to be 100, dying in 1975. Mrs. Fuller had worked for three years under the Social Security program. The accumulated taxes for that time totaled $24.75—and up to her death, she collected a total of $22,888.92 in benefits.
Clearly, Social Security plays a significant role in how we prepare for life after labor. Longer life means greater expense. I’ve never yet met anyone who wasn’t glad to begin receiving that monthly check. What we do need to talk about, however, is the typical series of mistakes people make when it comes to Social Security. We need to think more in-depth about this income stream and how we should be approaching it and planning for it.
The first and perhaps greatest misperception about Social Security is to think of it as a self-contained island, something apart from other investments and income.
On the surface, it seems simple: Here’s a program we began paying into when we first launched our careers. The government has held our money as we grew older. Now it’s coming back to us with interest, at a time when we need it most. End of story.
Here’s the truth: Social Security is a bit more complex than that. It’s not an island but something interconnected with your other assets, your overall financial picture, your cash flow, and your taxes. In other words, it’s a mistake to assume all that matters is what’s written on the check you receive. Some think, “I’m going to receive X dollars each month from now on. Why wouldn’t I want that to happen, beginning as soon as possible?”
Yet there are good reasons to look before you leap into accepting monthly payments. There are many more factors in play than simply the sum you’ll receive. It’s ultimately about the total assets you have, how they’re performing, the effect of taxes, and several other factors. All of this requires careful thought.
Simplistic thinking can create inefficiencies in the use of your other assets.
In addition to your overall financial picture, it makes sense to take another factor into consideration: the market at this moment in time.
I hope everyone has learned by now that the stock market isn’t quite a constant, smooth, fully predictable ride. These last few years, the stock market has been on a prolonged winning streak. But for how long? Nobody knows.
If you’re considering taking your Social Security payments, you’ll want to ask if that particular moment is the best time for you to file—or whether it would pay to play the waiting game a bit longer.
When you were born enters into this decision, too. If you were born before 1950, your full retirement age is 66. If you were born during the fifties, the age will be 66 and a few months. And for those born after 1960, the age of full retirement is 67. This, of course, is the first time you can begin receiving full benefits.
You can actually take checks at the age of 62, but your payments are reduced by a percentage relating to how early you’ve filed. Whatever your full retirement age may be, from 62 to that point in time, there’s a 7 percent guaranteed growth rate in your payment for every year you defer.
It’s an example of delayed gratification. You can have some money now—it’s always welcome. But if you wait, you can take your payment at a higher rate. That’s even more welcome, but it requires patience and an ability to take the long view.
If you continue to defer, from your full retirement age until you reach seventy, there’s actually an 8 percent growth rate in your payment. If you do the math, the amounts become significant. So you can see that the decision to activate Social Security payments is a bit less simple than it first appears.
Most people fail to consider the tax impact on Social Security, but it makes a great deal of difference. And this angle has its own set of rules.
The key here is provisional income, which is a formula. The IRS defines it as the sum of your gross income, capital gains and qualified dividends, and nontaxable interest, plus 50 percent of your annual Social Security benefit. Provisional income levels determine the point at which Social Security income can be taxed. If you stay below that threshold, you can receive your entire benefit tax-free.
There are odd aspects to the provisional income and its effect on Social Security. A couple living in retirement on $10,000 per month might pay full-rate taxes on Social Security—85 percent of their benefit being taxed at the federal tax rates. Someone else might have the same income per month during retirement, $10,000, while paying no taxes at all on the Social Security payment.
The point is, it’s not about your overall tax liability or how big your paycheck might be. This is very specific to Social Security: it’s the source of your paycheck, what type of money you’re receiving, and where you’ve saved that will make the difference. The tax overlay must be taken into consideration, and then the stock investment overlay as well.
The wrong question is, “How soon can I start receiving that nice check?” We need to ask, “Do I need my Social Security for cash flow? How does this overlay with my personal investments? And what impact will this have on my least favorite uncle—Sam? Simple, right?
Sometimes, I run the Social Security maximization algorithm a couple of ways for clients. Just for perspective, I run it based on a plain-vanilla strategy (or lack thereof), filing for Social Security at full retirement age, with, let’s say, a $3,500 per month benefit. I ignore the complicating factors, and check the financial result for the client after, say, twenty years, when he or she might be in the mid-eighties in age.
Then I run the algorithm again, based on the best financial advice and strategies, considering all the variables we’ve discussed here.
The difference in these two approaches? Hundreds of thousands of dollars in cash received over a few years. That extra money, under the first option, is just being thrown away. It’s as if it’s sitting in a bank account with the client’s name on it, unclaimed.
For more advice on Social Security, you can find Spending Money and Having Fun on Amazon.
Brad Gotto, Retirement Income Certified Professional (RICP), founded Fiat Wealth Management in 2009 to help clients align their money with their personal beliefs. He uniquely applies techniques in behavioral finance, investigation, and mathematics to unlock personal freedom. Host of the podcast, Every Day is Saturday, Brad provides financial education workshops for families free of charge throughout the Twin Cities, where he lives with his wife, Christy, their two sons, William and Hudson, and their Golden Retriever, Kinnick.