Think Before You Take That First Step!

I recently received the following question from an attorney and wanted to share it with you because it could help you as you work with and support your clients and friends who have the same situation. “‘My father asked me, ‘Now that I have turned 65, I plan to draw on your mother’s Social Security benefit and continue working. How do I go about doing this?’ My parents are both 65, are highly compensated ($300,000 plus), and plan to continue working into the foreseeable future. Is this a good idea?”

After I fell out of my chair, I asked the attorney where his father got this idea. He said an insurance agent trying to sell him Medicare Advantage suggested this as being a good strategy. Good is a very subjective word. Also, not knowing all of the facts and circumstances is problematic. However, more likely than not, this is not a good idea. Claiming a Social Security retirement benefit sooner than it is needed can be a costly mistake. The mistakes in this scenario are found by looking at the Social Security rules, the income tax rules; as well as, general principles for retirement planning.The first mistake is a costly one and concerns the income taxation of the Social Security Benefit. My presumption is that the parents are filing a joint income tax return.  If their “combined income” (adjusted gross income + nontaxable interest + ½ of the Social Security Benefit) is more than $44,000, than 85 percent of the Social Security Benefit is income taxable. Their “combined income” (absent any other facts) exceeds $432,200. Income at this level is taxed at 44.6% (39.6% [Federal] + 5% [average state income tax rate]. They would lose almost half the Social Security Benefit to income taxes. Also, the additional income may affect other areas of their tax return beyond their effective tax rates.

The second mistake has to do with the Social Security rules. The strategy proposed by the father is called “claim and suspend.” However, a spouse can only use this strategy if the other spouse has reached full retirement age. For someone born in 1942 (age 65) full retirement age is age 65 and 10 months. So this strategy is not yet available to him.

The third mistake has to do with how the math is calculated for the Social Security Benefit. Social Security retirement benefits increase each year up to age 70. Delaying drawing on the Social Security Benefit, even for a few years can substantially increase the size of the Social security benefit.

The fourth mistake is that this technique is only useful if one of the spouse’s social security benefit is substantially higher than the other spouse’s benefit. In addition, this technique will only be beneficial if one of the spouses is ready to retire.

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