Social Security Changes: How Do They Affect You?

In the previous two blog posts, Jeff Cedarholm shared his view on the changing investment landscape. Today’s post is focused on the changing landscape of Social Security. The expected lower market returns over the next 5-10 years and the changes to Social Security will make financial planning as important as it has ever been.  These changes don’t just affect those already receiving Social Security benefits; they affect anyone who will qualify for Social Security at some point in the future.

So what is new with Social Security and what does it mean for you?

By now, you’ve probably heard the concern over the sustainability of Social Security for the long term. It has been a subject well discussed and documented, especially over the last several years. In the summary of the 2015 annual trustees report for Social Security and Medicare programs1, the public is warned that given the current trajectory, Social Security reserves will run out in 2034. Based on this report, there are currently enough reserves that the interest earned on those reserves will continue to cover the difference between the employment tax that is brought in each year and the amount of benefits paid out each year until 2019. At that time, the reserves will have to be used toward the deficit. That is, until they run out in 2034. Once the reserves are gone, it is estimated that employment tax income will be sufficient to cover around 75% of expenses. After years of kicking the proverbial can down the road, the government decided in 2015 to take action to begin to improve the long term outlook for the Social Security program.

Insert the Bipartisan Budget Act of 20152 passed in November 2015. This act includes language that changes three filing strategies for Social Security, lowering future costs for the program, and reducing potential future benefits for many. While this certainly should not be considered a cure-all for the Social Security program, and the actual long term effects are still unknown, this is an indication that the government is looking at ways to lower future liabilities and improve the sustainability of the program. Let’s take a closer look at the changes:

  1. File-and-Suspend: This filing strategy allows a spouse to file for benefits at his/her full retirement age, which is currently 66, so that the spouse can obtain a spousal benefit. The taxpayer would then suspend his/her benefits, allowing for deferral until age 70. The taxpayer’s Social Security benefit would grow by 8% for each year of deferral between full retirement age and 70.

Let’s look at an example:

Assume that Sam and Sally are both 66. Sam has a higher benefit.  In order to maximize their benefits, Sam could file for his benefit, giving Sally the opportunity to file for her spousal benefit (half of Sam’s benefit), and then Sam could suspend his benefit, deferring it until age 70. This could result in Sam’s benefit at age 66 of $1800/month increasing to $2376/month at age 70. Using this strategy, Sally could receive $900/month in benefits based on Sam’s record versus her benefit of $750/mo. Using this strategy, they would be able to receive more benefit than they would have if Sally had just claimed her benefit and Sam had postponed his benefit or had taken it at full retirement age.

With the changes in the law, the file-and-suspend strategy can no longer be used after April 30, 2016. Instead, a taxpayer must file and receive benefits in order for the spousal benefit to be available.

  • Restricted Application: Filing a restricted application allows a taxpayer who has reached full retirement age to file for spousal benefits without filing for his/her own benefits. The taxpayer can then delay his/her benefits to age 70, allowing for an increase of 8% a year.

Let’s look at an example:

Tom is 68 and Jane is 66. Tom began taking his Social Security benefit of $1600/month at age 66. Jane could file a restricted application at age 66 to claim spousal benefits of $800/month and allow her benefit to continue to grow until she reaches age 70. If her benefit was $1900/month, she would begin receiving a benefit of $2,508/month at 70 after receiving $800/month for 4 years.

The restricted application strategy is still available for anyone who turned 62 by December 31st, 2015. Anyone who is 62 or older after December 31st, 2015 will be limited to the deemed filing rule, which states that you are applying for any benefits for which you qualify. This means that an individual cannot restrict their benefits to allow for growth, but instead would receive the higher of his/her personal benefit or the spousal benefit at the time of filing.

  • Lump-sum payout of suspended benefits: Before the 2015 Budget Act took effect, an individual who chose to file and suspend could request a lump sum payout of all of the suspended benefits instead of opting for the 8% increase in benefit between full retirement age and age 70. This do-over might prove to be a good option for someone who, after deciding to delay benefits, found out that he/she had an illness or other factor that may shorten their life or require a large sum of money. 

Taxpayers can still unsuspend benefits. The taxpayer’s benefit will be increased for the higher rate applicable for delaying past their full retirement age. However, the taxpayer no longer has the option to choose to receive the lump sum payout of the benefits accrued between full retirement age and the unsuspension age.

Let’s look at an example:

Sam decides to postpone his benefit and uses the file and suspend strategy. At age 68, he is told he has an illness that will shorten his life considerably and result in additional medical expenses of $15,000/year. Before the Budget Act of 2015, Sam could have received the accrual of his benefits between ages 66 and 68, an amount of $43,200, and started his Social Security payment, which would have been the payment he qualified for at age 66 – $1800/mo. That lump sum could be used to help pay for his increased expenses. Now, if Sam unsuspends his benefits at 68, he will be limited to just receiving his monthly Social Security benefit. The benefit will be indexed for the 2 years of deferral. So a payment of $1800/month at age 66 would now be $2088/month, but there would not be a lump sum payout.

(Please note this reinstatement of benefits is for the full time between age 66 and 68 because Sam chose to file and suspend. Simply delaying benefits without using the file and suspend strategy would have resulted in only 6 months of a retroactive benefit.)

Your view of this law change will likely depend upon your age. The closer you are to your Social Security full retirement age, the larger the pill may be to swallow. For those who are 50 or younger, the change may seem more attractive because the current forecast for reserve funds isn’t great enough to cover 100% of your projected Social Security payment at normal retirement age anyway. Regardless of your age and your view, it does affect you in some way.  As of now, there are still opportunities for those between the ages of 62-66 to be grandfathered in under the old law for the restricted application and file-and-suspend strategies. Those under 62 should focus on ways to maximize benefits under the new law. One of the easiest ways to do this is to plan on postponing benefits until age 70. Doing this still results in an 8%/year increase in benefits.

This is an area where we help clients. We are currently in the process of reviewing options and possible recommendation changes for our clients who are 62 and older and are not currently receiving Social Security benefits.

1 The 2015 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Federal Disability Insurance Trust Funds. House Document 114-51. 22 July 2015. Act of 2015. Pub. L. 114-74. 2 Nov. 2015.