At a recent AICPA conference, three CPA tax practitioners, including the author, engaged in a conversation about client services, noting in particular that all were fielding more questions from clients about timing strategies for claiming Social Security retirement benefits. Two of the CPAs heartily offered that they always advise clients to begin claiming benefits as early as possible — age 62.
Their responses were surprising for two reasons. First, the word "always" rarely applies when discussing Social Security benefits. Second, it is less common that an analysis would support beginning benefits at age 62, except when there is only one record to consider. Interestingly, when the author mentioned this conversation to another CPA, that CPA quickly commented that those CPAs were mistaken, stating that she always tells her clients to delay claiming until age 70 to maximize their benefits.
There was that word again: always. When advisers do not know the answer to a complex question, they are tempted to generalize. However, in the case of Social Security, the strategy that seems best on the surface is often found to not be the optimal strategy after pulling back the covers and considering the individual's unique circumstances.
The confidence with which these CPAs offered their advice of when to claim Social Security raised the question of how other CPAs advise clients when they are asked the same question. While many CPAs have conflicting views on Social Security, it seems that all are very interested in considering the topic further to help clients answer two looming questions:When can I retire? Will I have enough money to retire?
It seems that defined benefit pensions are a thing of the past for most clients. Other retirement plans, such as a 401(k), have worked for some, but they have come up short for others, who, on the precipice of retiring, regret not having saved more. Clients wonder, either consciously or subconsciously, whether they will outlive their assets, given unknown health care costs, inflation, and stock market volatility.
Of course, clients want to maximize every potential source of income. Social Security is usually the most straightforward piece of the retirement income puzzle to estimate. Benefits are paid under a legal formula. Payments do not rise and fall with the markets or depend on company performance, though whether Social Security actually keeps up with inflation is another matter to take into account.
Even so, Social Security is a great foundational place to start retirement planning. While Social Security was never intended to provide full support in retirement, this inflation-protected income stream, which could pay out over $1 million over an individual's lifetime, can help.
Below are the top seven mistakes clients make when claiming Social Security benefits and ways to help prevent them:1. Relying on general information
Most clients learn what they know about Social Security from the periodicals they read, friends and family, and the Social Security Administration. This generic information could mislead clients into making decisions that would not be most favorable for their unique situation. Even with the best intentions, sometimes clients just "don't know what they don't know." This is especially important with a nuanced topic like Social Security. Wherever clients receive their information about Social Security, they should verify it with someone who understands the intricacies of their personal situation and the dynamic Social Security rules.
The CPA financial planner is the ideal person to help provide this advice. The CPA already knows the client's tax situation and likely much more about the client. The CPA is in a unique position to advise the client on the best strategy.2. Omitting critical considerations
Life expectancy, physical health, income needs, spousal and survivor benefits, and plans for how long one will work should all be considered in deciding when to apply for benefits. Overlooking one of these factors can lead a client directly to the wrong strategy. For example, even when a client retires early, it can be advantageous to delay claiming Social Security if the client's family history and current health indicate she will likely live well into her 90s.
The CPA financial planner should already be having these conversations with the client in the normal course of planning. These factors are especially important to consider given people's increased longevity, making the continuous income stream provided by Social Security especially important. The CPA can effectively broaden the vision of clients who do not believe they will live as long. It is important to keep in mind the medical advances on the horizon and that people in higher socioeconomic levels typically have a longer lifespan than what is purported in the news. It is smart to plan for the likelihood that one person in a given couple will live to age 100.3. Misunderstanding key calculations
Understanding the way benefits are calculated is important in helping a client maximize them. The benefit calculation is based on an average of how much a client has earned each year, up to $128,700 (the inflated-adjusted Social Security wage base for 2018), for her 35 highest earning years. In any years that income was not earned, the input is $0, bringing down the client's benefit if the client worked less than 35 years. Therefore, in an attempt to build up benefits, the CPA financial planner could propose the client consider working additional years to fill up $0 or other low-earning years. Also, knowing that the calculation will be based on earnings up to $128,700 in a given year, the CPA could recommend the client consider ways to increase earned income if her earnings are currently below this ceiling.4. Failing to coordinate benefits
While looking at Social Security in isolation may yield one recommendation, a completely different recommendation may emerge as most advantageous when considered through the lens of the client's financial plan. Coordinating Social Security benefits with pensions; personal assets; cash flow (including required minimum distributions, or RMDs); and earned income is critical because actions in one area often have a direct effect on another. For example, it can be advantageous for someone with significant pretax retirement accounts to claim benefits earlier than she would otherwise to avoid depleting the retirement accounts' principal too quickly. On the other hand, if she is able to bridge the income gap with a portfolio of significant after-tax assets, delaying benefits can be a very viable strategy.
Data from the Social Security Administration illustrate how delaying benefits results in increased Social Security later in life, which can be a great planning idea if the client has taxable portfolio assets to bridge the gap until Social Security benefits begin. The chart, "Cumulative Individual Benefits," (below) illustrates how this works, using the assumptions from the examples that follow:
Example 1: R turns 62 in 2018 and has a full retirement age (FRA) for Social Security purposes of 66 years and 4 months. At full retirement, R's monthly Social Security benefit would be $1,300. If R starts taking Social Security benefits upon turning 62, however, her monthly benefit would be reduced (permanently) to $953. If she lives to age 90, her total Social Security payout would be $320,208 versus a $369,200 total payout if she had waited until FRA to start receiving benefits. As long as she lives past age 78 years and 2 months, delaying benefits until FRA will result in a larger lifetime payout; if she dies before that age, the strategy of taking Social Security benefits at age 62 will result in a larger payout.
Example 2: Assume the same facts as Example 1, except R delays taking Social Security benefits until she turns 70. In that case, her monthly benefit would be $1,681. If she lives to age 90, her total payout will be $403,440, more than $83,000 greater than her payout if she started at age 62. If she lives to at least age 82 years and 6 months, this strategy will result in a greater lifetime payout than starting at FRA.
5. Misinterpreting early application vs. delaying benefits
Everyone is assigned an FRA, between age 66 and 67 for most current workers, based on the year they were born. Whether a person begins claiming benefits at FRA, earlier, or later is personal. A number of factors should be weighed in helping a client make the decision (i.e., life expectancy, health, income needs, spousal and survivor benefits, work plans). If the client begins claiming the benefit earlier than her FRA, the benefit is reduced between 5% and 6.7% annually from age 62 until FRA. Delaying benefits increases her benefit by 8% annually for each year she delays claiming after FRA through age 70. (Delaying her benefit can mean 32% more if her FRA is 66 and 24% if it is 67.) The reduction or increase lasts the rest of her life.
Note: If applicable, survivor benefits (for widows or widowers) can be received from age 66 to 70 while the survivor's earnings record grows (until the survivor switches it at age 70). A similar strategy can be used for couples, where at least one of them was born before 1954 and both are living. (This group was grandfathered under rules that are no longer available for most of the population.) This strategy would entail the lower-earning spouse claiming spousal benefits, when eligible, while letting that spouse's own record grow until age 70 (at which time the lower-earning spouse could move to claiming on her own record). Advisers should be on the lookout for clients who meet these specific criteria to avoid leaving benefits on the table.
6. Forgetting about spousal and survivor benefits
There are many cases and times in life where multiple people may be calculating benefits from one record. Consider the following:
- Spouses should elect to receive payments that are either based on their own work record or up to 50% of their spouse's benefit, whichever is higher.
- Those married at least 10 years can also claim Social Security benefits based on their ex-spouse's work record (or their own).
- When a spouse dies, the surviving spouse can inherit the deceased spouse's benefit payment, if it is greater than his or her own. This makes it especially advantageous for the higher earner in a couple to delay claiming benefits so that the survivor can receive a maximized benefit.
Regarding the last point above, many people fall into the trap of thinking that a Social Security claiming strategy is an individual decision when it is actually a household decision. Without proper guidance, the client's first inclination will often be to go ahead and begin collecting benefits at FRA or sooner, considering what the claimant sees as his or her likely lifespan for receiving benefits. However, CPAs should advise the client to think about a spouse's lifespan as well. The CPA financial planner should advise the client to consider that when one person in a marriage dies, the other person receives the higher benefit of the two people going forward. (This is often referred to as the widow benefit, due to the fact that women tend to have greater longevity than men.) Therefore, the breadwinner, in particular, should consider delaying benefits so that the surviving spouse will receive the highest benefit possible. If funds are needed sooner, a hybrid strategy (where the higher earner delays while the other spouse takes benefits earlier) may be most advantageous.
7. Misframing Social Security planning
As noted previously, the greatest retirement concern for most clients, at every socioeconomic level, is that they will run out of money. While it is advisable to look at how to maximize benefits for a particular client, it is important to view this through the lens of a long life expectancy such as age 100.
The compulsion to try to guesstimate how long one might live to beat the averages established by the actuaries and come out ahead is understandable. But this analysis misses the point. The beauty of Social Security is that it provides people with inflation-adjusted monthly payments that are determined by established legal formulas. It is a steady bulwark against poverty in an environment with fewer pensions, volatile financial markets, increasing health care expenses, and increasing longevity. It is important to remind clients that, consistent with the program's original intent, it should be viewed as longevity insurance. When he signed the Social Security Act in 1935, President Franklin Roosevelt stated: "We can never insure 100% of the population against 100% of the hazards and vicissitudes of life, but we have tried to frame a law which will give some measure of protection to the average citizen and to his family against the loss of a job and against poverty-ridden old age."
Keeping the long-term view
Should CPA financial planners help clients maximize total benefits they receive from Social Security? Absolutely. However, CPA financial planners are in an excellent position to explain why the client should not do it to the detriment of the benefit's longevity aspects. Having knowledge of their clients' overall plan, the CPA can demonstrate how Social Security, as longevity insurance, is another important aspect of managing risk, just as the CPA would advise them on any other type of insurance in managing their overall plan risks.
Should clients claim benefits at FRA, delay, claim early, or create a hybrid strategy that incorporates more than one of these? Unfortunately, there is no "always." The only certainty is that it "always" depends. No Social Security claiming strategy is one-size-fits-all. Every client has unique concerns to plan for. CPA financial planners can use their unique view into the client's situation, in conjunction with their knowledge of Social Security, to create a customized strategy for each client.
Social Security will need to transform and adapt to be sustainable. Therefore, CPAs must stay abreast of changes so they can plan strategies to maximize their best features. •
This report contains no recommendations to buy or sell any specific securities and should not be considered investment advice of any kind. This presentation is for informational purposes only and is not an offer to sell any product. It does not constitute investment, legal, or tax advice and should not be used as a substitute for the advice of a professional legal or tax adviser. The investments or strategies discussed may not be suitable for all investors. In making an investment decision, individuals should utilize other information sources and the advice of their investment adviser. Information was obtained from third-party sources that we believe to be reliable but are not guaranteed as to their accuracy or completeness.
Stearns Financial Group is a registered investment adviser. SEC registration does not constitute an endorsement of the firm by the Commission nor does it indicate that the adviser has attained a particular level of skill or ability. More information about the adviser, including its investment strategies and objectives, are fully described in the firm's Form ADV Part 2, which is available by calling (336) 230-1811, or can be found by visiting www.stearnsfinancial.com. SFG-18-83
Paula S. McMillan, CPA/PFS, CGMA, CFP, is a senior financial planner and adviser with Stearns Financial Group in Greensboro, N.C. Theodore J. Sarenski, CPA/PFS, is chairman of the AICPA Advanced Personal Financial Planning Conference. He is also a past chairman of the AICPA Personal Financial Planning Executive Committee and a former member of the Tax Literacy Commission. For more information about this column, contact firstname.lastname@example.org.