Speaking at the Morningstar Investment Conference in June, John Bogle, founder of The Vanguard Group, hit the nail on the head. Bogle, who is pretty much the father of modern retirement planning strategy, said that “Social Security’s the greatest fixed income you’ll ever get,” and went on to argue that “It doesn’t matter what the stock market is worth as long as the income keeps coming from dividends. In the long run, focus on the dividend stream, and focus on the fact that Social Security will keep coming.”
Bogle isn’t the only person to champion an income-focused approach to retirement planning. Dave Littell and his colleagues in the Retirement Income Program at The American College are literally writing books on the subject, and they are encouraging both financial advisers and the public to adopt a new mindset when it comes to retirement planning. Instead of thinking about the $1 million or $2 million nest egg that is traditionally targeted by savers, think about how your savings will translate into future income — dividend streams from investments, payments from annuities, and, yes, Social Security payments.
“For years, financial services companies have downplayed the role of Social Security in bolstering financial security in retirement,” reads a report from James Mahaney, vice president of strategic initiatives at Prudential Financial, a major insurance and investment management company. “However, considering the increased financial risks retirees now shoulder, the tax preferences that Social Security receives, and the income options that Social Security now offers, a strong argument can be made that Social Security should play a greater role in a retiree’s financial planning.”
Here are a couple of strategies to maximize Social Security benefits.
1. You will reap in proportion to what you sow
The amount of Social Security benefits you receive are calculated based on “your average indexed monthly earnings during the 35 years in which you earned the most.” In order to reach this number, the Social Security Administration takes your actual earnings in each of your 35 highest-income years (up to a maximum of $113,700 in 2013) and then adjusts those earnings by an index. This adjustment is meant to compensate for the change in average wages over time, effectively ensuring that past earnings are put into the calculation at current purchasing power. Total adjusted earnings for the 35 years are added together and divided by 420 (the number of months in 35 years). Keep in mind that if you’ve worked less than 35 years, zeros are factored in to fill in the gaps.
The number that this process spits out – for the sake of the example, let’s say it’s a clean $5,000 — is broken into three brackets. The first bracket is from $0 to $816, the second bracket is from $817 to $4,971, and the third bracket is anything over $4,971. Bracket one earns a 90% return from the SSA, bracket two earns a 32% return, and bracket three earns a 15% return.
For our hypothetical, this comes out to $734.4 (bracket one) plus $1,329.28 (bracket two) plus $4.35 (bracket three) for an estimated monthly Social Security retirement benefit of $2,068.03. With this in mind, make sure to calculate your Social Security retirement benefit whenever you sit down to build or edit your retirement strategy.
2. Take it slow, if you can afford it
Remember that estimated monthly Social Security benefit of $2,068.03 we calculated? That’s the estimated benefit if you begin withdrawing at age 66, the full retirement age (age 67 for those born after 1960). You are technically eligible to withdraw at age 62 — if you do, however, you suffer a permanent 25% reduction in your monthly benefit. That $2,068.03 per month turns into $1,551.02, a difference of $517.01 per month, or $6,204.14 per year.
That, to put it simply, is an enormous amount of money. Most financial planners generally argue that if you can get away with waiting until full retirement age to start withdrawing, you should do it, even if it means making withdrawals from savings accounts, other retirement vehicles, selling financial assets, or working longer.
And the longer you wait, the better — up to a point. Your benefits increase at a yearly rate of 8% for each year you defer retirement for up to three years, until age 70.
3. Your spouse could help
“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,” writes Mahaney in his report. This, of course, shouldn’t stop people from sitting down and trying to sort it all out.
The spousal benefit allows someone to claim a benefit worth up to one half of a spouse’s benefit. So at the age of full retirement, if one spouse’s benefit is less than one half of the other spouse’s benefit, then they are eligible for spousal benefits. The benefit will make up the difference.
4. Don’t let taxes sink your battleship
Up to 85% of your Social Security benefits are subject to taxation, depending on how much money you make. Here’s the tricky thing, though: When you start claiming Social Security benefits, half of those receipts count toward your “combined income,” which is what the IRS will use to determine how much of your Social Security it wants to take back. The combined income equation is your adjusted gross income plus nontaxable interest, plus that half of Social Security receipts.
For a single filer, if this comes out to more than $25,000 per year, you will owe some taxes on up to 50% of your entire Social Security income. If it comes out to more than $34,000, you will owe taxes on up to 85% of your benefits.