The Social Security Administration in its publication, Social Security Basic Facts (2017), reports that 50 percent of unmarried individuals and 71 percent of married couples rely on Social Security benefits for 50 percent or more of their total retirement income. Some 23 percent of unmarried individuals and 43 percent of married couples rely on such benefits for 90 percent or more of their retirement income! Notwithstanding the fact that Social Security was never intended to constitute such a sizeable portion of a worker’s retirement income, most participants want to ensure that they maximize their retirement benefit from Social Security to the greatest extent possible. Accordingly, other than delaying the start of benefits as long as possible until a maximum age of 70, there are four other methods to maximizing Social Security benefits. They are:

1) Improve the participant’s earnings record with the Social Security Administration

2) Take advantage of any spousal and survivors benefits available under the Social Security program

3) Minimize income taxes on Social Security benefits

4) Consider Social Security as only a part of the participant’s total accumulated savings generating retirement income or retirement income strategy

Earnings Record

There are two methods of improving the participant’s earnings record with the Social Security Administration (SSA) and, thus, maximizing his or her total benefits. These are: 1) work longer and delay benefits; and 2) earn more during the participant’s working years.

If a participant born after 1943 delays the receipt of Social Security retirement benefits until attaining age 70, a maximum amount of monthly benefits will be achieved. Specifically, an annual credit of eight percent (8%) is awarded to the participant for each year delaying the receipt of a benefit beyond his or her full retirement age (FRA). For example, a participant born in 1950 with an FRA of age 66 and with a monthly benefit of $1,500 per month, can increase his or her monthly benefit under Social Security by 32 percent to $1,980 ($1,500 times 1.32) if delaying the receipt of the benefit to age 70. This amount could be increased even further by a cost-of-living-adjustment (COLA) announced by the SSA at the end of each calendar year. 

The second method of improving a participant’s earning record is for the worker to earn more money throughout his or her working years when paying into the system. When determining retirement benefits, the SSA first calculates the worker’s “average indexed monthly earnings” (“AIME”) during the 35-year period of the worker’s highest annual earnings. The SSA then applies a formula to those earnings and arrives at a basic benefit, otherwise referred to as the worker’s “primary insurance amount” or “PIA”. (Note: It is this PIA that is indexed for the COLA and increases if the consumer price index of prices also rises.) As a result, if there are a greater amount of worker’s earnings accumulated over the 35-year AIME period, there will be a greater PIA from which to determine the worker’s monthly retirement benefit.

It is important to understand that, currently, only a certain, maximum amount of earnings is accounted for when determining a worker’s AIME and, thus, his or her PIA. This maximum amount of earnings is known in Social Security law as the worker’s “taxable wage base” (TWB) and increases each year based on the rate of inflation. The amount is announced each year, at calendar year-end, by the SSA. The TWB is also the maximum annual amount on which a worker contributes to Social Security or pays a “payroll tax”. Above this amount (TWB), the worker does not qualify for Social Security retirement benefits; thus, a Social Security benefit is not payable for amounts earned above the TWB.

Spousal and Survivor Benefits

A spousal benefit of up to 50 percent of the participant worker’s (other spouse’s) PIA is payable to the spouse at his or her FRA. This is the result even if the electing spouse is not otherwise eligible to receive Social Security retirement benefits on his or her own earnings record. For example, if Jack, the participant worker, has a PIA of $2,000 per month at his FRA of age 66 , and Jill, his spouse, applies for a spousal benefit at her FRA, she will receive a benefit of $1,000 per month or 50 percent of Jack’s PIA. Alternatively, Jill could have elected to retire “early” (at age 62) and apply for spousal benefits using Jack’s earning record, but her benefit may be reduced to as little as 32.5 percent of Jack’s PIA. Finally, if Jill was born before January 2, 1954 and has reached her FRA, she can choose to receive only Jack’s benefit and delay receiving her own retirement benefit until age 70 (commonly referred to as the “suspend and file” strategy). 

A survivorship benefit is also payable to the surviving spouse of a deceased participant worker. The surviving spouse, sometimes known as the “widow” or “widower”, may receive the larger of his or her own retirement benefit (PIA) or the deceased worker’s benefit (PIA) when the widow or widower attains FRA. (A reduced benefit from the deceased worker’s PIA is payable when the widow or widower attains age 60.) To maximize the survivor’s benefit that is payable, the deceased worker should delay taking his or her retirement benefit as long as possible since the survivor’s benefit reflects any delayed credit. If the deceased spouse died before his or her FRA, the survivor benefit is based on the amount the deceased spouse would have received at his or her FRA. Alternatively, if the deceased spouse died after his or her FRA and had not yet begun benefits, the survivor is eligible for the deceased spouse’s date-of-death benefit, including delayed-retirement credits.

Minimize Income Taxation of Benefits

Prior to 1983, there was no Federal income tax imposed on Social Security benefits. However, in 1983, and after Congress introduced a concept known as “provisional income” (“PI”) into the tax law, approximately 40 percent of participants pay tax on receipt of Social Security benefits.

The computation of “PI” is made in three steps:

1) Start with gross income not including any Social Security benefits.

2) Add back any tax-free income, such as municipal bond interest or dividends, and any foreign earned income. This amount is known as the taxpayer’s “modified adjusted gross income” or “MAGI”.

3) Calculate 50% of Social Security benefits and add that amount to steps 1 and 2 total to determine the taxpayer’s PI.

Depending on the total amount of PI and a taxpayer’s filing status, compare the PI to several “hurdle amounts” as follows:

Then, apply the following rules:

1) If the taxpayer’s PI is less than the 1st hurdle, there is no tax on the Social Security benefit (it is tax-free).

2) If the taxpayer’s PI is between $25,000 and $34,000 ($32,000 and $44,000 for a married filing jointly taxpayer), up to 50 percent of Social Security benefit is, generally, taxable.

3) If the taxpayer’s PI is more than $34,000 ($44,000 for a married filing jointly taxpayer), up to 85 percent of Social Security benefit is, generally, taxable.

So how does an individual minimize the taxation of Social Security benefits? One alternative is to keep one’s PI below the hurdle amounts. Barring this relatively unfavorable alternative (meaning the taxpayer is living on a relatively small amount of income), a second alternative is to not invest in tax-free investments, such as municipal bonds, or work in another country. Still, a third alternative is to suffer a reduction in Social Security benefits, such as some public-school teachers and federal civil service employees, because of a provision in the Social Security law known as the Windfall Elimination Provision (WEP).

Social Security as Part of Overall Retirement Income Strategy

When the program was implemented in 1935, Social Security was intended only as a supplement to an individual’s total retirement income! Thus, a worker should accumulate as much income as possible from the other two legs of the “three-legged retirement stool”. How? By taking advantage of 1) employer-sponsored retirement plans and 2) personal tax-deferred savings accounts.

An individual preparing for retirement usually supplements Social Security benefits with salary reduction before-tax contributions to an employer-sponsored plan, such as a Section 401(k) plan, and tax-deductible contributions to a traditional IRA and, sometimes, after-tax contributions to a Roth IRA. In such manner, the portion of total retirement income constituting Social Security is reduced, usually to an average of between 35-40 percent for most retirees. 

*Excerpts from upcoming book entitled “Planning for the Elderly: A Financial Guide to Aging”, to be published later in year 2020