What You Think You Know about Social Security Could Hurt You – Part 1

Note:  As we wrote this the public trustees of the Social Security programs reported that its fiscal health has significantly worsened. See our companion story in our Blog, “Social Security Crisis Worsens“.

We were vain enough to consider ourselves experts on when and how to start collecting social security. That is, until we heard a talk last week by Kurt Czarnowski.  Boy, the things we didn’t know, and the others so misunderstood! This article will give a brief background on Social Security and then dive into successful strategies for optimizing your return from this important safety net.

Part 2 of this series will focus on issues related to claiming strategies for couples, the rights of divorced spouses, and frequent misunderstandings/questions about Social Security.

About Czarnowski ConsultingKurt Czarnowski is currently the principal in “Czarnowski Consulting,” a retirement planning company which provides “Expert Answers to Your Social Security Questions.” Czarnowski is the former Regional Communications Director for the Social Security Administration (SSA) in New England, a position he held from December 1991 until his retirement at the end of 2010.

First, let’s start with a quote from Kurt Czarnowski: “The myths and misunderstandings about Social Security are staggering”. This from a man who spent 34 years within the Social Security Administration, the last of those as a Communications Director. Given all the misinformation, it is important that we all address this topic with an open mind. Note that this article was prepared from notes as well as our observations. If there are any errors they undoubtedly stem from our misunderstanding and not as any reflection on Mr. Czarnowski.

Social Security – A Safety Net
This 76 year old program was designed as a safety net for seniors, widows, and the disabled. It was never meant to be the sole source of retirement income; rather it was meant to be the base to help supplement income from pensions, savings and investments, and other income.

To be eligible for a retirement benefit you first need to become “vested”, which means you have to have earned 40 credits from Social Security. In 2012 you get 1 credit for each $1130 you earn, with a maximum of 4 credits per year. Employees currently pay 4.2% on their earnings (up to a maximum of $110,100 in 2012). In addressing a question from the audience, Mr. Czarnowski commented that for an individual who has not earned their 40 credits, it might be worth while taking a job to do so, given the potential value of the payout over time (including some considerations about your Part B premiums).

How Social Security determines your benefit
It is worth knowing how the Social Security Administration calculates your retirement benefits, once you become eligible and decide to start collecting. These are the 3 steps in determining your benefit:

1. Adjust prior year earnings to current dollars. This neutralizes your early year earnings, which are unreasonably low in today’s dollars.

2. Take the average of your 35 highest earning years. Non-working years are counted as 0's.

3. Adjust the benefit according to income. This progressive approach means is that lower earners get a higher percentage benefit (56%) relative to their earnings than do middle earners (41%). The highest earners get the smallest percentage (34%).

The average monthly Social Security retirement benefit paid in 2012 is $1,229, or $14,748 per year – hardly enough for a comfortable retirement by itself.

How much you collect depends on when you start collecting
The age you have attained when you start collecting has a major impact on the size of your monthly check. The program is designed to be neutral no matter when you start – assuming an average life expectancy.

For workers born between 1943 and 1954 (the baby boomers and a few years older):
Age 62       Benefit  is  75% of the Full Retirement Benefit
Age 66       Benefit  is  100% of the Full Retirement Benefit
Age 70       Benefit  is  132% of the Full Retirement Benefit

Your benefit increases the longer you wait to start collecting – up to age 70. Note that you can start collecting at anytime after age 62 (for example, 63 years and 2 months). Your benefit will be adjusted according to a formula. Between age 62 and your Full Retirement Age (FRA) – 66 for baby boomers – the benefit goes up .5% per month. Between FRA and age 70 the benefit increases .666% per month, or 8% per year.

Myth busters – working in retirement
How your benefit is affected by working is one of the most misunderstood aspects of Social Security. In general Mr.Czarnowski and other experts all agree that there is no reason not to work, even though your social security benefits might be reduced if you claim your benefits and work before you reach your FRA.

The theory is that it is better to have more money, rather than less.

Between the ages of 62 to 65 there will be a reduction of your benefits of $1 for every $2 you earn above $14,640.

In the year you reach FRA your benefit will be reduced by $1 for every $3 you earn above $38,880.

Once you attain your Full Retirement Age there is no reduction in your benefits, no matter how much you earn.

Taxation of Social Security
About one third of social security recipients pay income tax. If you earn more than $25,000 (individuals) or $32,000 (filing jointly) you are required to pay tax on up to 85% of benefits received. Additionally, there are several states that tax social security (although most do not).

Collection Strategies
Mr. Czarnowski gave us the clearest explanation of various collection strategies we have ever heard. Which is not surprising since he is in demand as a consultant with leading financial planners, assisting individuals in their social security planning. Here are some of the key strategies he discussed.

Delay taking your benefits?
Mr. Czarnowski stresses that the decision on when to take Social Security is yours, but you do need to know the facts before you decide.

Social Security retirement benefits are structured to be neutral, regardless of when you start claiming, assuming that the average person lives to be 78.

If you die before then, you were better off claiming early. If you claim later to get a higher monthly benefit and then live to be 100, you will have hit the Social Security jackpot, because your monthly benefit would have been so much higher for all of those extra years beyond 78.

Factors affecting your decision
There are 4 major factors you need to consider when deciding when to start claiming your social security:

- Your health. If you have a serious health condition that might affect how long you will live, earlier collection is probably better.

- Family life expectancy. Assuming you are healthy, how long did your parents live? How about siblings? If your genes point to living into your 80's or beyond, delaying your claiming date might be wise.

- Do you need the money. If you got laid off and your job prospects aren’t that good, you might need to claim early just to stay afloat. But if you can live using other savings, you still might consider delaying.

- Are you still working. Since your benefit will be reduced if you earn more than a modest amount before your full retirement age, there is not much point in claiming before your FRA. Plus, if you are in your high earning years, there is even more reason to delay claiming your benefit. That’s because you might be able to drive up your 35 year earning average, which will increase your future monthly payments.

The effect on your surviving spouse also needs to be considered
When the first spouse dies the survivor has two options: he or she can keep their own benefit, or take over their spouse’s. For the couple with a higher earning spouse, the benefit of taking the delayed benefit is magnified. Not only does the higher earner get the higher benefit during his or her lifetime, but the surviving spouse will also benefit as long as he/she lives.

Next time – Issues related to couples and when to take Social Security
Married couples need to carefully consider their options before claiming Social Security in order to maximize their lifetime benefits. We will explore those options and different claiming strategies in more detail in Part 2, along with other issues such as the rights of divorced spouses.




For further reference:
Part 2: Marital Claiming Strategies, the Rights of Divorced Spouses, and Frequent Misconceptions
Exploding 5 Myths about Social Security (Jane Bryant Quinn for AARP)
It Pays to Work in Retirement
When Should You Start Taking Your Social Security Benefits
10 Things You Need to Know Before You Start Taking Social Security
Too Many Boomers Leave Money on the Social Security Table
Social Security Administration: Social Security Benefits Estimator
Comments?  What are you thinking about your Social Security claiming strategies? Please share your thoughts in the Comments section below.


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