Few people can rely completely on Social Security to fund their retirement. However, it often serves as a central source of income. When retirement planning, you need to think strategically about your approach to Social Security. This means learning how the benefit is calculated and establishing a plan for maximizing your payment.
As a general overview, the amount of your monthly benefit depends on your work and income history, as well as the age at which you begin to claim it. Making a mistake when it comes to Social Security can cost you a considerable amount of income in the long run, especially considering that the benefit is received monthly from the time it is claimed until your death.
Some of the common mistakes made when it comes to Social Security include:
1. Delaying payments past the age of 70.
You are allowed to start claiming Social Security before you reach full retirement age, but the benefit is reduced to reflect this fact. By the same token, you can continue to wait past full retirement age and increase your benefit by 8 percent per year.
Individuals who do not absolutely need the benefit, especially those who are still working, may think they can just keep holding out to maximize the benefit. However, the increases for delayed claims stop once someone turns 70. At that point, the maximum benefit has been reached and it makes sense to start claiming the income. Otherwise, the income is simply lost.
People who can afford to do so should wait until they turn 70 to start claiming but then ensure they file for Social Security as soon as they reach that age. The Social Security Administration will actually pay up to six months of retroactive benefits, but the best bet is not to delay at all.
2. Hiding income from the IRS.
The Internal Revenue Service (IRS) can take legal action against people who are found to be hiding income and not paying taxes on it. Moreover, hiding income will likely result in a lower Social Security benefit once you retire.
The monthly benefit from Social Security is based on the highest-earning 35 years of a person’s life. When you hide income, your reported income is reduced. To get the highest benefit, you need to report a high income.
Saving on taxes in the short run is often not the best decision, considering the effect it will have on your Social Security benefit down the road. Reporting income accurately helps you avoid penalties and legal action while resulting in additional monthly income down the road. Since your Social Security benefit lasts for life with regular cost-of-living adjustments, maximizing it makes the most sense, and that is dependent on maximizing overall annual earnings.
3. Working fewer than 35 years prior to retirement.
As mentioned above, your Social Security benefit is calculated by averaging your highest 35 years of income. When you have fewer than 35 years of work history, the missing years get entered as zeros into the equation.
Thus, even someone who made a large amount of money for 20 years will have their average significantly reduced by the introduction of 15 zeros. Average income in this instance will be nearly halved.
Unfortunately, not everyone is in a position to achieve a 35-year work history, and the coronavirus pandemic has caused record rates of unemployment. This means that you may need to delay retirement to maximize your work history, especially if you are only a year or two short of the 35 mark.
4. Creating debt in order to delay claiming your benefits.
People are often told that they need to delay claiming their benefits as long as possible. Indeed, as explained above, delaying your claim can significantly increase your payments. Waiting four years past full retirement age increases your monthly benefit by nearly a third. However, you should not delay if you cannot afford to do so.
Sometimes, individuals will take on credit card debt or apply for loans to make ends meet when they are eligible for Social Security. In the end, the interest paid on this debt can quickly start to outweigh the financial benefit of delaying your claim.
Choosing to claim benefits at full retirement age or even early can make sense for some people who would otherwise need to go into debt to make ends meet. In some cases, you may be able to repay the benefit and delay your claim if your situation improves. However, even if this is unlikely to happen, claiming the benefit makes more sense than going into debt.
5. Claiming without coordinating with your spouse.
If you are married, you need to coordinate your Social Security strategy with your spouse, as maximizing your benefits will require a different strategy than if you were each single. Planning with a spouse becomes most important when there is a clear earning disparity between the two parties.
A partner can claim the benefits of the higher-earning spouse through the survivor benefit, but only if the higher-earning individual has already started receiving Social Security. In general, it makes sense to maximize the benefit of the higher earner by delaying that individual’s claim as long as possible. This is because that will guarantee the most income for the remainder of both individuals’ lives.
Maximizing the benefit of the lower earner takes secondary priority. This means it is acceptable to claim the benefit early if doing so makes it possible to delay claiming the other benefit. However, it is important that both parties start receiving Social Security prior to either passing.