Strategies to maximize your benefits

Social Security is supposed to be a security blanket for most Americans, but lately it hasn’t felt all that comforting. Because of the cost-of-living formula used by the Social Security Administration, benefits recipients are not receiving an increase in 2011 for the second year in a row. And under current rules, the entire Social Security system is in danger of becoming insolvent. To avoid that, the cochairs of a bipartisan commission on the federal deficit recently proposed raising the normal retirement age, increasing the annual limit on income that is subject to the Social Security payroll tax and other controversial changes.

Bottom Line/Personal asked Social Security expert Theodore Sarenski to address some of the questions and concerns that many people have…

Q: Why are benefits not rising when it feels like living expenses are going up and up?
The Social Security cost-of-living formula has not been particularly fair to retirees lately. The formula’s inflation index hasn’t climbed for two years largely because home values have plummeted and car prices have stagnated. But retirees typically don’t buy a lot of homes and new cars. Many of the things that they spend on — health care, heating fuel and utilities, for example — have in fact increased in price.

Cost-of-living increases are likely to resume once real estate values stabilize. Meanwhile, remember that there was a big 5.8% cost-of-living increase in benefits three years ago. The system wouldn’t seem quite so unfair if that increase had been spread evenly over the past three years.

However, under a proposal by the deficit commission’s cochairs, cost-of-living adjustments would become less generous starting in 2012 under a new formula.

Q: Are benefits going to end if the Social Security system starts to run out of money?
No. It is true that the system is expected to run a deficit by 2015, and its reserves are indeed on course to be depleted — but not until 2037. Most likely, the government will make changes in the tax and/or benefits rules in time to prevent that.

Even in the very unlikely event that the reserves are completely depleted, the system would still be able to pay around 75% of its obligations through 2084 by distributing the taxes paid into the system each year by those still in the workforce.

Q: How likely is it that the government actually will make changes to Social Security?
My prediction is that politicians will keep feeding us Social Security scare stories every election year, but they will not substantially alter the system for many years, perhaps even decades. In the 75-year history of the Social Security system, lawmakers have always waited until disaster was imminent before making changes. That said, America’s budget problems are very pressing, and politicians might conclude they cannot solve these problems without slashing the cost of the Social Security system.

Q: What are the possible changes?
In addition to changing the cost-of-living formula, the commission cochairs made the following proposals, which the full commission had not yet voted on as of press time…

Slowly raise the normal retirement age to 68 by 2050 and to 69 by 2075… increase the early retirement age from 62 to 64… and at the same time provide a “hardship exemption” for people physically unable to work past age 62. The normal retirement age increase would affect only people born after 1960. Currently, the normal retirement age for people born in 1960 or later is 67.

Gradually raise the annual limit on income subject to the Social Security payroll tax from the current $106,800 until it’s near $190,000.

Give retirees an option to collect half their benefits early and the other half at a later age. This would allow early retirees to draw some income from the Social Security system, perhaps to supplement income from a part-time job, while also allowing some of their benefits to continue to grow by delaying them until age 70.

Establish a new special minimum benefit to keep low-wage workers above the poverty line.

Provide a “benefit bump-up” for older retirees equal to 5% of the average benefit. The bump-up would be phased in over five years, starting 20 years after a retiree first becomes eligible for benefits.

The cochairs also proposed several alternative changes, which include increasing benefits for low-income widows or widowers… capping the spousal benefit at one-half the average worker’s benefit, rather than one-half the partner’s benefit… and reinstating college benefits for child survivors — benefits that were eliminated in 1981.

Q: How can I maximize my benefits?
Unless poor health or family history suggests that you are likely to pass away before age 77, you’ll get more money from the system by waiting until your late 60s or age 70 to start receiving your benefits. Delaying the start of benefits until at least age 66 is attractive if you are married because it increases your partner’s spousal and survivor benefits, too, by up to 8% per year.

Strategies to maximize benefits…

“62/70 strategy.” Married people should consider this. The lower-earning spouse, usually but not always the wife, claims benefits based on her own earnings at age 62, with her husband claiming spousal benefits on her earnings as soon as he reaches his full retirement age — 66 if he was born between 1943 and 1954. Then the husband switches to his own benefits when he turns 70, with his wife switching to spousal benefits based on his earnings. This couple receives the largest possible benefit checks after the husband turns 70 but still gets benefits before then.

“File-and-suspend” strategy. If one spouse has no significant earnings history, this strategy is a second option. Here, the wage-earning spouse files for benefits when he reaches the normal retirement age, then immediately asks that those benefits be suspended. Then his partner can claim spousal benefits based on his suspended account, while the amount that will be on the wage earner’s eventual monthly checks continues to grow until he ends the suspension in his late 60s or at age 70, the age at which the benefits rate stops rising.

Q: For someone who would like to work a few more years, is there a risk that taking a low-paying job at the end of a career will drive down the earnings history on which his/her future Social Security checks will be based?
Continuing to work is far more likely to increase someone’s eventual Social Security benefits than it is to reduce them even if the late-career job doesn’t pay well. Benefits are computed based on the 35 highest-earning years among your final 40 working years, not on the final salary, as they are with some pension plans.

If someone has worked for fewer than 35 years, even a small paycheck will boost benefits because it will replace $0 earning years in the calculations.

If the person already has 35 working years, the small paychecks might not boost the earnings history but will make it easier to delay the start of Social Security benefits past age 62, thereby increasing eventual monthly checks by up to 8% per year, simply based on age, until age 70. Just try to avoid starting benefits while you’re still working — that would increase the odds that your benefits will be taxed.

Working additional years is likely to reduce Social Security benefits only if someone already has worked 40 years and had high earnings in the early years relative to the rest of his career. Continuing to work in this situation could bump those long-ago high-earning years out of the most recent 40 working years, removing those years from the benefits equation.

Q: For someone in debt who is worried that creditors and debt collectors are going to grab his Social Security benefits, is there anything that can be done to protect those benefits?
Creditors and debt collectors usually cannot legally garnish Social Security benefits. Unfortunately, when banks receive court orders directing them to freeze accounts, they often do so, even when the accounts contain Social Security assets. Most account holders don’t fight this because they don’t realize it is illegal.

If this happens to you, be sure to contact the bank and point out that Social Security income is in the account and cannot legally be frozen. Then insist that the assets be released. Be aware, however, that Social Security benefits can be legally frozen or garnished if the debt involves unpaid federal income taxes or child support.

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