Following up my article which provided several brief examples of the Social Security Spousal Benefit, I thought I’d provide some further explanation and background for the provision. It appears from some of the feedback I have received that there is a great deal of confusion over this provision, so hopefully the further background explanation that I’m providing here will be of help.

I have listed below several additional background details about how the Social Security System works, in order to help you better understand the prior article.

Additional Background Explanation

As stated at the outset of the previous article, this is one of the most confusing provisions of the Social Security system. Don’t expect to fully understand the tenets of the provision in a brief reading – you’ll want to read through the examples carefully, comparing each example to your own situation and considering the outcomes.

1. In the original article, I used two acronyms in my explanations, both of which were explained briefly at the outset of the article. I’ll explain and define each of them further here.

FRA – Full Retirement Age. This is the age at which you would become eligible for your full Social Security benefit (also known as your Primary Insurance Amount, which we’ll get to next). It used to be that FRA (Full Retirement Age) was 65 for all people – but with the 1983 amendment to the system, the age was gradually increased. Full Retirement Age (FRA) depends on your year of birth, according to the table below:

PIA – Primary Insurance Amount. This amount is, for most folks*, equal to the amount that you would receive at Full Retirement Age (FRA). This figure is the primary figure against which all calculations are run for figuring your retirement benefit, and for calculating a Spousal Benefit for your wife or husband.

* If an individual is also receiving a pension from a job which was not subject to Social Security withholding taxes, such as a teaching job or a federal, state or local government job, certain reductions will likely apply. You can read more about the impact of these non-Social Security jobs at this article which explains the Windfall Elimination Provision and the Government Pension Offset (WEP and GPO respectively, if you’d like more acronyms).

2. There is a minimum age at which you become eligible for Social Security retirement benefits, and this is the same for all people, 62. If you file at this age (or at any age before Full Retirement Age), you will be subject to a reduction from your Primary Insurance Amount (PIA) based upon the number of months you’re filing before Full Retirement Age. It’s a somewhat complicated formula (but then again, what about this system isn’t?) so rather than explaining how to build a watch I’ll show you what time it is.

The table below shows the reduction factors for various ages and years of birth. You’ll need to find the row for your Year of Birth, and then work your way across to the right for your reduction factor at various ages. Space limitations don’t allow us to display every possible age (limited to exact years), but you can get the idea of how the reduction works for ages in-between.

To use this table, find your Year of Birth in the first column. Move right until you reach the age that you wish to begin early benefits. This figure is the amount of reduction from your Primary Insurance Amount (PIA, see the explanation above) that you will experience by filing at this age.

At the earliest filing age of 62, for a person who was born in 1960 or later the reduction factor will be -30%. In other words, if this person files for benefits at age 62, the benefit would be 70% of the amount that this person would receive if he or she waited until Full Retirement Age (FRA) of 67 to file for benefits.

(FYI – there is also a maximum age for all people, after which your Social Security benefit will no longer earn delayed credits, and that is age 70. Delaying receipt of your benefit after Full Retirement Age causes an increase to your benefit, up to age 70.)

3. A Spousal Benefit can be available to one spouse or the other but not both. The maximum amount that this benefit could be is 50% of the other spouse’s Primary Insurance Amount (PIA, the amount that he or she would receive at Full Retirement Age). The 50% amount is available if the spouse applying for the Spousal Benefit is at least Full Retirement Age. If he or she is younger than Full Retirement Age, a reduced amount could be available. The reductions are listed below:

Following the example listed above where a person born in 1960 or later files for Spousal Benefits at age 62, the 50% factor is reduced by 35%. In other words, the Spousal Benefit factor for this person would be reduced to 65% of the full 50% factor, which calculates to 32.5% of the other spouse’s PIA.

4. Furthermore, the Spousal Benefit is only available if the other spouse has filed for benefits already. Stay with me on this – it’s confusing. This means that until the other spouse files for retirement benefits, the first spouse can’t file for Spousal Benefits. Once the other spouse files for retirement benefits, the first spouse, as long as he or she is at least age 62, can file for Spousal Benefits. It’s important to note that the Spousal Benefit is available only to one spouse in the couple at at time – not both, so you have to choose which option works out better for you and your spouse.

5. At Full Retirement Age, a special provision is available that allows one spouse or the other to file for her own benefit and then suspend receiving the benefit; this will enable the other spouse to file for Spousal Benefits based upon the first spouse’s record. Since the one spouse has suspended receiving her benefit, she can continue to accrue delayed retirement credits up to age 70, while at the same time the other spouse is now eligible to file for Spousal Benefits based upon her record.

6. If the Social Security recipient is filing for benefits prior to Full Retirement Age and he is also eligible for the Spousal Benefit at the same time (that is, his spouse has already filed for her own benefit), then another special provision applies, called Deemed Filing. Deemed Filing requires that, if the individual is eligible for both the Spousal Benefit and his own benefit and is younger than Full Retirement Age, then that individual must file for both benefits at that time. The only other alternative is not filing for either benefit.

If the individual is not currently eligible for the Spousal Benefit and he is filing for his own benefit prior to Full Retirement Age, Deemed Filing does not apply – even if a month later his spouse files for her own benefit, making this first spouse eligible for the Spousal Benefit. Deemed Filing only applies in the first month that the individual is filing for his own retirement benefit, and then only if he is younger than Full Retirement Age. (Roles could be reversed, as always.)

Back to the examples

Now, with this additional background information, you should be able to go back to the first article and it will (hopefully) make more sense.

Keep in mind what I mentioned at the beginning: this is complicated. Don’t expect to pick up on it immediately. If all this does is raise questions, feel free to post your questions in the comments and I’ll try to address your questions as best I can.

In addition, bear in mind that I am an independent financial advisor; I don’t work for the Social Security Administration. As such, in these articles I am reporting the way the system works – not advocating it, not agreeing with it, not defending it. I agree that many of the provisions of the system can be unfair when applied, but I don’t have any sway with the Social Security Administration to fix the problems. I’m a taxpayer just like you, and I have to deal with the system the way it stands as well.

I have spent quite a bit of time studying how the system works in order to help my clients. As a result of my study of the system, I’ve also written a book that you may find useful – A Social Security Owner’s Manual. The Spousal Benefit and many other confusing provisions of the Social Security system are explained in the book.

You can pick up my book, A Social Security Owner's Manual, at Amazon in either the print version or the Kindle version by clicking the links.
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It’s usually best, for most things in the financial world, to act now rather than waiting around. The notable exception is with regard to applying for Social Security benefits. We’ve discussed it before (in fact part of this article is a re-hash of an earlier post) but it is an important point that needs more emphasis, in my opinion. As you’ll see from the table below, if you’re in the group that was born after 1943 (that’s you, Boomers!) you can increase the amount of your Social Security benefit by 8% for every year that you delay receiving benefits after your Full Retirement Age (FRA – see this article for an explanation).

Delaying Receipt of Benefits to Increase the Amount

If you are delaying your retirement beyond FRA, you’ll increase the amount of benefit that you are eligible to receive. Depending upon your year of birth, this amount will be between 7% and 8% per year that you delay receiving benefits – which can be an increase of as much as 32½% if you delay until age 70 and you were born in 1941 – when your FRA is 65 years and 8 months, and the increase amount is 7½% per year at that age. See the table below for the increase amounts per year based upon birth year:

So you can see the impact of delaying receipt of retirement benefits – it can amount to more than 50% of the PIA (Primary Insurance Amount), when you consider early benefits versus late benefits. Of course, by taking benefits later, you’re foregoing receipt of some monthly benefit payments; given this, early in the game you’d be ahead in terms of total benefit received. This tends to go away as the break-even point is reached in your mid-70′s to early-80′s in most cases, which we’ll review in a later article.

An Example

Here’s an example of the benefit of delay in action: You were born in 1954, and as such your FRA is age 66. According to the benefit statement you’ve received from Social Security, you are eligible for a monthly benefit payment of $2,000 when you reach your FRA (which would be in 2020). If you delayed applying for your benefit until the next year, your monthly benefit payment would be $2,160 per month – an increase of $1,920 per year. If you delayed until age 68 (two years after FRA), the monthly payment would be increased to $2,320, for an annual increase of $3,840. At age 69, delaying would increase your annual benefit by $5,760, and at age 70, your monthly payment would be $2,640, for an annual benefit of $31,680 – $7,680 more than at FRA. This amounts to a 32% increase in your benefit by delaying receipt of the benefit by 4 years!

Notes

It’s important to note that this is not a compounding increase – that is, your potentially-increased benefit from one year is not multiplied by the increase for the following year. The factor for each year (or portion of a year) is simply added to the factor(s) from prior years. You also don’t have to wait a full year to achieve the benefit – this delay is calculated on a monthly basis, so if you delayed by 6 months your increase would be 4% over the FRA amount. The biggest benefit of this is that you can not only increase the amount you will receive over your lifetime, but also the survivor benefit that your spouse will receive upon your passing. For some folks this can make a huge difference as they plan for the inevitable.

You can pick up my book, A Social Security Owner's Manual, at Amazon in either the print version or the Kindle version by clicking the links.
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You might not know this, but it’s a fact that Social Security retirement benefits are not designed to provide retirement income in the same ratio to all levels of wage earners.  The system, being a social insurance system, benefits folks who have had lower income levels through their lives at a higher rate than folks who have had higher incomes.

So, what are the replacement rates that are experienced?  Of course it is different for each individual, but some averages are listed in the table below:

This is just a representative sample of various levels of lifetime average income.  It shows how, at lower income levels, Social Security replaces a much higher ratio of the pre-retirement income.  This means that at higher income levels, a higher amount of savings must be laid aside in order to ensure that adequate income is available for retirement.

This is not to say that the system is broken or unfair – it’s working exactly as it was intended to, by providing a measure of insurance to those who need it most.

You can pick up my book, A Social Security Owner's Manual, at Amazon in either the print version or the Kindle version by clicking the links.
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For those of you who aren’t quite up to snuff on the carnage that makes up the Social Security retirement benefit calculation, there are a couple of figures that are important to the calculation process called Bend Points.  Bend Points are the portions of your average income (Average Indexed Monthly Earnings – AIME) in specific dollar amounts that are indexed each year, based upon an obscure table called the Average Wage Index (AWI) Series. They’re called bend points because they represent points on a graph of your AIME in calculating the PIA, and they actually bend.

If you’re interested in how Bend Points are used, you can see the article on Primary Insurance Amount, or PIA. Here, however, we’ll go over how Bend Points are calculated for each year. To understand this calculation, you need to go back to 1979, the year of the Three Mile Island disaster, the introduction of the compact disc and the Iranian hostage crisis. According to the AWI Series, in 1979 the Social Security Administration placed the AWI figure for 1977 at $9,779.44 – AWI figures are always two years in arrears, so for example, the AWI figure used to determine the 2012 bend points is from 2010.

With the AWI figure for 1977, it was determined that the first bend point for 1979 would be set at $180, and the second bend point at $1,085. I’m not sure how these first figures were calculated – it’s safe to assume that they are part of an indexing formula set forth at that time. At any rate, now that we know these two numbers, we can jump back to 2010’s AWI Series figure, which is $41,673.83. It all becomes a matter of a formula now:

Current year’s AWI Series divided by 1977’s AWI figure, multiplied by the bend points for 1979 equals your current year bend points.

So here is the math for 2012’s bend points:

• $41,673.83 / $9779.44 = 4.2614
• 4.2614 * $180 = $767.05, which is rounded down to $767 – the first bend point
• 4.2614 * $1,085 = $4,623.59, rounded up to $4,624 – the second bend point

And that’s all there is to it. Hope this helps you understand the bend points a little better.

You can pick up my book, A Social Security Owner's Manual, at Amazon in either the print version or the Kindle version by clicking the links.
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The 3.6 percent cost-of-living adjustment (COLA) will begin with benefits that nearly 55 million Social Security beneficiaries receive in January 2012. Increased payments to more than 8 million SSI beneficiaries will begin on December 30, 2011.

Some other changes that take effect in January of each year are based on the increase in average wages. Based on that increase, the maximum amount of earnings subject to the Social Security tax (taxable maximum) will increase to $110,100 from $106,800. Of the estimated 161 million workers who will pay Social Security taxes in 2012, about 10 million will pay higher taxes as a result of the increase in the taxable maximum.

You can pick up my book, A Social Security Owner's Manual, at Amazon in either the print version or the Kindle version by clicking the links.
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Much has been written about the ills of our Social Security system as it stands today.  There has been considerable banter about how the system is a Ponzi scheme (it’s not), how it will go bankrupt soon (it can’t), and how we’ve got to do something about it soon (we do) like abolishing it completely (we can’t).

The above issues have already taken up a lot of cyber-paper, as many other writers have covered them far more completely than I will attempt here.

Briefly, the Ponzi concern is out of the question, as the Social Security system isn’t a savings plan, it’s an insurance plan.  And, like all insurance plans since many receivers of benefits have put little if anything into the plan (dependents and survivors of participants, for example), many participants will receive less from the plan than they put into it.  The Social Security system was never intended to pay you back what you put into it – it’s a social insurance system, so many pay into it with little return.  Like it or not, that’s what we’ve put in place, and that fact is not likely to change.

The bankruptcy question is resolved by the fact that the system always has new money coming into it from tax rolls, which means it cannot be bankrupted.  The system could become insolvent, meaning more is going out than is coming in, but since the amounts paid out to new recipients can (and will) be adjusted, this insolvency won’t happen either.  Of course this means that the people paying into the system will receive fewer and fewer benefits as time goes on, which leads us to the next point.

We’ve got to do something to repair the system, but abolishing it isn’t the answer – it’s not even among the viable answers.  I’ve seen it written elsewhere that we could just shut down the system and give all current participants (those who have paid in) an account equal to the amount that they’ve put in, since there’s a trust fund holding non-marketable bonds already.  However, with so many folks relying on the system to provide benefits when they didn’t put anything into it, or didn’t put as much into it as they are receiving in benefits (such as folks on disability), abolishing the system altogether would leave these folks out in the cold.

What may work

Means testing is one of the matters that must be addressed.  As it relates to all forms of benefits, presently the only means test results in ordinary income tax on up to 85% of the benefits received.  This doesn’t go far enough – being a social insurance program, benefits are guaranteed to all eligible persons, including those who have no need for the funds in any way, such as the über-rich. I’d suggest that the means testing should go even farther than that, to include those not-so-über-rich, with incomes that far encompass the need for this additional social insurance.

Another area to resolve problems with our current system is in the complexity of the way it works and how benefits are paid to people.  There is a tremendous amount of bureaucracy involved with administering, responding to questions, and working through complaints with the way the system currently works.  If the system were changed to force folks to only file for retirement benefits at Full Retirement Age (FRA) and not before or after, much of this complexity would be removed.  Along with the removal of the complexity, much of the bureaucracy could be eliminated, reducing the overhead and costs, making the system more efficient.

By setting one specific age for retirement benefits, we would also have much better control over outflows from the system, and adjusting FRA would have an immediate and calculable impact on the system.  Granted, the impact on recipients would also be immediate under this proposal.

Don’t get me wrong, I’m not suggesting that this will fix everything.  We’ll have to get the actuaries involved to figure out how much of an impact these changes could have.  The end result is probably going to be that current drags on the system will require further reduction in benefits than I’ve proposed and/or additional taxation in order to keep the benefits flowing.  But taking a few steps right now can help to forestall the presently inevitable outcome.

If you’re looking for more on how the Social Security system works today, check out my new book – A Social Security Owner’s Manual. The book provides a well-rounded look at how your benefits work – you’re bound to find something you didn’t know.

You can pick up my book, A Social Security Owner's Manual, at Amazon in either the print version or the Kindle version by clicking the links.
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The Rules

There are a couple of different levels of income that determine how much of your Social Security Benefit is taxed.  The first level is $32,000 for a married couple filing jointly (MFJ) or $25,000 for single, head of household and qualifying widow(er) filing statuses.  If your Modified Adjusted Gross Income (MAGI) plus half of your Social Security benefit is less than this first level for your filing status, none of your Social Security benefit is taxable.

The second level is $44,000 for MFJ or $34,000 for the single filing statuses.  If your MAGI plus half of your Social Security benefit is greater than the first level but less than the second level, then as much as 50% of your Social Security benefit may be included in your taxable income.

If your MAGI is above the second level, then as much as 85% of your Social Security benefit may be included in your taxable income.

Like most calculations in the tax code or where Social Security is involved, it’s a mess to understand.  I’ll give you some examples below to illustrate how this works.

Examples

Here are a few examples:

Example 1. Married Filing Jointly, MAGI = $15,000; SS = $15,000

Since the PI is less than the First Level, none of the SS benefit is taxed.

Example 2. Married Filing Jointly, MAGI = $25,000; SS = $20,000

Since the 50% level amount is greater than zero, half of the amount above the 50% level will be added to the taxable income for the couple.  None of the benefit is includable at the 85% rate.

Example 3. Married Filing Jointly; MAGI = $45,000; SS = $20,000

Since the SS benefit was greater than the upper limit, a portion of the benefit is included at the 50% rate, and another portion is included at the 85% rate, for a total addition of $15,350 to taxable income for the couple.

Example 4. Married Filing Jointly; MAGI = $55,000; SS = $20,000

Since the PI was greater than the 85% level, we did the same type of calculation as in Example 3, except that this time the total of the 50% taxed amount and the 85% taxed amount was greater than 85% of the overall SS benefit, so only that amount is added to the taxable income for the couple.

Hopefully these examples will help you to better understand how the amount of taxable Social Security benefit is calculated for various situations.

You can pick up my book, A Social Security Owner's Manual, at Amazon in either the print version or the Kindle version by clicking the links.
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Social Security Survivor Benefits are much different from Spousal Benefits in several ways.  In fact, there’s very little to compare between the two.  Here are the primary things that you need to know about Survivor Benefits:

• Survivor Benefits can be claimed as early as age 60.  Of course, as with all early claims for benefits, the amount will be reduced if you claim earlier than Full Retirement Age (FRA). At age 60 your Survivor Benefit would be reduced to 71.5% of your late spouse’s benefit amount (or PIA if he or she wasn’t at FRA).
• Survivor Benefits are based upon 100% of the amount of benefit (at your FRA) that the deceased spouse was or should be receiving, whereas Spousal Benefits are based upon the PIA, and then only at a 50% maximum rate.
• Survivor Benefits can also be applied for separately from your own retirement benefit – meaning that you can receive Survivor Benefits while delaying receipt of your own retirement benefit (if it’s higher) in order to receive Delayed Retirement Credits up to age 70.
• Survivor Benefits are only payable if the surviving spouse has not remarried before age 60.  After age 60, the surviving spouse can remarry and still receive Survivor Benefits based upon the deceased spouse’s record.
• A disabled surviving spouse can collect benefits as early as age 50 – at the same rate as if waiting to age 60 – 71.5% of the deceased spouse’s benefit.
• If a surviving spouse is caring for a child under the age of 16, Survivor Benefits can be claimed until the child or children are over age 16.  This benefit is equal to 100% of the deceased spouse’s benefit (or PIA if the deceased spouse was not receiving benefits).
• Survivor Benefits can also be paid to children of the decedent, provided they are under age 19 and a full time student.  If the child is disabled (prior to age 22), Survivor Benefits can still be paid to the child after age 19.  The child’s Survivor Benefit is at a 75% rate of the decedent’s benefit.

These Survivor Benefit rules also apply to ex-spouses who become widows or widowers, as long as the ex-spouse was married to the ex-spouse for at least ten years.

You can pick up my book, A Social Security Owner's Manual, at Amazon in either the print version or the Kindle version by clicking the links.
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The 20/40 Rule

If you have become disabled after you’ve left employment, you may be eligible for Disability Benefits – assuming that you’re under Full Retirement Age (FRA).  In a case such as this, if you have worked the required number of quarters to be eligible for Disability Benefits, the rule is that you must have worked 20 quarters out of the previous 40 quarters, earning at least the minimum.

This is the 20/40 Rule.  The quarters don’t need to be consecutive, but it must be 20 out of the 40 quarters prior to the onset of the disability.  Another way to look at it is that for five years after you leave employment you will be covered by Social Security for Disability Benefits, again assuming that you’re under FRA.

If you work, even part-time, ($1,120 earned in a quarter), this will count as a quarter for your coverage.

The 20/40 Rule is adjusted for age, as well.  If you’re under age 24 when you become disabled, you must have worked for 6 quarters out of the prior 12 quarters before you become disabled.  Between ages 24 and 31, the numbers are half of the quarters after your age 21 – so if you’re 29, you would need to have 16 of the 32 quarters after your age 21.  After you reach age 31, the 20/40 Rule lives up to its name – 20 quarters out of the prior 40.

Once you reach FRA, Disability Benefits are converted to Retirement Benefits, so this rule doesn’t need to be considered.

You can pick up my book, A Social Security Owner's Manual, at Amazon in either the print version or the Kindle version by clicking the links.
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File and Suspend works like this: One of the two in the couple can file an application for Social Security benefits and then immediately suspend in order to not receive the benefits. This can allow the other spouse to utilize the first spouse’s record to receive a Spousal Benefit.  Other eligible dependents (such as children under 18) can also receive benefits based upon the filed and suspended record.

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There are a few factors to note about File and Suspend:

• You must be at least at Full Retirement Age (FRA) to File and Suspend.
• Either spouse can File and Suspend, but not both.  By Suspending, you are not eligible to receive a Spousal Benefit.
• If the non-Suspending spouse is under FRA and begins receiving Spousal Benefits, he or she will no longer be earning Delayed Retirement Credits (DRCs) on his or her own record.  Plus both the Spousal Benefit and the “own” benefit of the non-suspending spouse will be permanently reduced by filing before FRA.
• The spouse that has not Filed and Suspended can receive Spousal Benefits based on the other spouse’s record at any age over 62 – but the amount of the benefit will be reduced if the spouse receiving Spousal Benefits is less than FRA.  At FRA, the Spousal Benefit would be 50% of the filed and suspended worker’s Primary Insurance Amount.

Why File and Suspend?

The main reason for File and Suspend is to allow the Suspending spouse to delay receiving benefits, earning up to 8% in Delayed Retirement Credits (DRCs) per year.  This will not only increase the amount of benefit that the Suspending spouse will receive when he or she files for benefits, but it will also increase the amount of Survivor Benefits for the other spouse.  At the same time, the other spouse can be receiving Spousal Benefits based on the first spouse’s record.

Here’s an example: The husband has a PIA amount of $2,300, and his wife has a PIA amount of $1,500.  The couple are both at FRA.  The husband Files and Suspends, and the wife can immediately begin collecting a Spousal Benefit equal to 50% of the husband’s PIA – $1,150.  At the same time, both spouses are accruing DRCs on each of their own records.  Both of them can delay filing for benefits on his and her own record until age 70, at which point they will each have achieved the maximum benefit on their own records.  When she reaches age 70, the wife will file for her own benefit and discontinue receiving the Spousal Benefit.  The husband will also re-file at age 70.

Another example: The wife has a PIA amount of $2,000, and the husband has a PIA of $1,000.  The wife is at FRA, and the husband is a year younger.  When the husband reaches FRA, the wife could File and Suspend, and the husband can begin receiving a Spousal Benefit of 50% of the wife’s PIA, delaying filing for his own benefit in order to receive the DRCs.

The husband in the second example could choose to begin receiving Spousal Benefits before FRA.  In that case though, he would not be eligible for DRCs.  This is due to the rule that requires a “deemed filing” if you file for Spousal Benefits prior to FRA.  A deemed filing is the same has having filed for your own benefit, and as such your benefit and the Spousal Benefit will be reduced, permanently, due to the early filing.

A third example: The husband has a PIA of $2,000 and the wife has a PIA of $500.  The husband is two years younger than the wife, she is 66 (FRA) and he is 64.  The wife has begun receiving her own benefit at FRA.  Since the husband is not yet at FRA, File and Suspend is not available to him.  However, once he reaches FRA, he can File and Suspend, and the wife can begin collecting a Spousal Benefit, increasing her own benefit to 50% of his PIA.

It’s important to note that for all of the examples, the spouse that is described as having Filed and Suspended could just as easily filed for his or her own benefit and begun receiving it immediately, rather than suspending.  This would also enable the other spouse to begin receiving Spousal Benefits.  The spouse that is collecting benefits on his or her own record would just no longer be accruing DRCs for his or her future benefit.

You can pick up my book, A Social Security Owner's Manual, at Amazon in either the print version or the Kindle version by clicking the links.
Post from: Getting Your Financial Ducks In A Row

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