For years, financial services companies have downplayed the role of Social Security in bolstering financial security in retirement. However, considering the increased financial risks, retirees are now burdened with the tax preferences that Social Security receives and the income options that Social Security now offers, a strong argument in favor of Social Security is being made.
Should Social Security play a greater role in a retiree’s financial planning?
The greatest fear for today’s retirees is not having enough money to maintain their lifestyle throughout retirement. Social Security can offer a valuable source of retirement income. For those age 65-74, Social Security accounts for 54% of total retirement income. It plays an even greater role as retirees age, accounting for 61% of retirement income for those 75-84, and 66% for those age 85 and older (Employee Benefit Research Institute, Issue Brief #383, p. 6, February 2013). With inflation-fighting increases, longevity protection, investment risk elimination, and spousal coverage, advisors should be more apt to find ways to optimize the benefits of social security.
Despite the important role Social Security plays in retirement, many retirees do not understand how their benefits really work. Sadder still, most advisors never focus on how to maximize the very benefits that may help sustain their clients throughout retirement. By adding Social Security income planning to your financial practice, you will be providing a valuable and much-needed service that few other advisors today are offering.
When speaking to your clients, it may be beneficial to bring up these 4 costly mistakes retirees make regarding Social Security.Mistake #1: Underestimating the real value of Social Security
As the income guarantees provided by private employer pension plans disappear, Social Security guarantees become even more critical to individuals who may spend 25, 30, or even 40 years in retirement. In reality, no retiree knows how long he or she will live and most run the risk of outliving their income. Social Security provides valuable protection against this “longevity risk.”
Mistake #2: Rushing to collect, then regretting the reduced benefits for the rest of their life
Compared to earlier generations of retirees, Social Security will replace less of pre-retirement earnings, as the Full Retirement Age has risen from 65 to 66, and is heading to 67 for those born after 1954. Nevertheless, retirees often apply for Social Security benefits early. Most people don’t stop to think that, once reduction penalties as well as foregone Delayed Retirement Credits and Cost of Living Adjustments (COLAs) are factored in, they could have potentially doubled their initial payments if they had waited until age 70.
Mistake #3: Not understanding the various ways married couples can integrate their benefits
Perhaps the most confusing aspect of Social Security claiming is trying to understand the different types of retirement benefits for which married spouses might be eligible, and how those benefits might interact with each other. At one time or another, a married spouse might be receiving a spousal benefit, a worker benefit or a survivor benefit. Whether both spouses worked and earned benefits or whether only one spouse did, there are ways to optimize benefits by developing a claiming strategy.
Mistake #4: Getting blindsided by the “Tax Torpedo”
Individuals for the most part understand that they face ordinary income taxation of their 401(k)/IRA withdrawals in retirement. Yet the tax situation is often worse for the retiree than expected. Once a very low-income Adjusted Gross Income (AGI) threshold is met ($25,000 for singles and $32,000 for married couples), every dollar received from an IRA causes up to 50% of Social Security retirement benefits to become taxed as well. At a second AGI threshold ($34,000 for singles and $44,000 for married couples), up to 85% of a Social Security retirement benefit will become taxable. These thresholds are NOT indexed to inflation. This situation may get worse if ordinary tax rates increase in the future.
Becoming An expert in Social Security Planning and Strategy
Retirees who employ a strategy that can withstand the risks they’ll face will have a better chance of enjoying a happier retirement. They will also be more likely to use and refer you for your other services if you help get them there.