Q&A: File and suspend strategy for Social Security

Dear Liz: You recently wrote an interesting piece regarding the “file and suspend” strategy for Social Security benefits. I liked the possibility of getting a lump sum if I should need the money downstream.

But when I checked with Social Security, I was told that the lump sum maximum was six months of suspended payments. Am I missing something? My understanding was that I could collect all the suspended payments if need be. Is there a specific code I could reference to our Social Security office to clear this matter up?

Answer: You’re not missing something. The Social Security representative you talked to is confusing retroactive benefits with the reinstatement of benefits that were voluntarily suspended.

When you file for benefits after your full retirement age (currently 66), the maximum lump sum you can get is six months’ of missed benefits.

When you “file and suspend” your application at or after full retirement age, however, you can end the suspension at any time and get a lump sum for all the benefits you missed.

Unfortunately, the misinformation you received isn’t unusual.

Financial planners around the country have reported running into Social Security reps who insist that only six months’ of benefits are available to people who file and suspend, which isn’t true.

The procedure is outlined in the Social Security Administration’s “Program Operations Manual System” under GN 02409.130 Voluntary Suspension Reinstatement

It’s also described in plain English on Social Security’s site: “If you change your mind and want the payments to start before age 70, just tell us when you want your benefits reinstated (orally or in writing). Your request may include benefits for any months when your payments were suspended.”

The ability to file and suspend, then change your mind, is an important protection for those who understand the important role Social Security plays as longevity insurance.

The smartest course is often to let your benefit grow to its maximum amount, taking advantage of the “delayed retirement credits” that increase your benefit 8% annually between your full retirement age (currently 66) and age 70.

If you should later find yourself in need of the money, you can get a lump sum payout for the missed benefits back to the day you filed and suspended, if you want.

But opting for the lump payment means you lose your delayed retirement credits for that period. In other words, if you ask for a lump sum dating back to your initial filing, your monthly benefit is reset to the smaller amount you would have gotten then.

Q&A: Social Security spousal benefits

Dear Liz: I started my Social Security benefits at 66 and am now 70. I was married for 23 years and have not remarried.

When I ask about spousal benefits, I am told that my own monthly benefit is too high to get benefits based on my ex’s work record. My monthly benefit is only $1,509, my 401(k) has tanked, and I am surviving on less and less available part-time work.

I was told further that I can apply once my ex passes away and then it won’t matter how high my income is. Could that be correct? What is the exact cut-off amount to get spousal benefits?

Answer: Many people misunderstand the way spousal benefits work, and they think that they can get an additional check on top of their own retirement benefit. That’s not quite how it works.

Essentially, Social Security compares the amount of your retirement benefit with what you would get as a spouse or divorced spouse and gives you the larger of the two. Spousal benefits are up to half of what your spouse or ex receives.

If your ex’s benefit is $2,000 a month, for example, your spousal benefit could be $1,000, which is less than you’re getting now. If your ex dies, however, you can apply for a survivor benefit that equals what he or she received — in this example, $2,000 a month.

Q&A: Retirement savings for freelancers

Dear Liz: I am a freelancer. I don’t consider myself a small-business owner, just someone who gets the work done on time and gets paid. I max out my IRA every year, but would like to save more in a tax-advantaged account.

I checked out SEP and SIMPLE IRAs, but they don’t have a Roth option. Am I eligible to start an Individual 401(k)? What administrative duties would be involved? I pay self-employment tax and my clients send me 1099s, not W2s.

Answer: You may not consider yourself a small-business owner, but that’s essentially what you are. And small-business owners should have tax pros to help them answer questions like this, since you have so many options.

As a sole proprietor, you should be able to set up a solo or individual 401(k) account. That would allow you to make either pre- or after-tax “employee” contributions of up to $18,000 in 2015 — plus an additional $6,000 if you’re 50 or older.

As your own employer, you can contribute an additional 25% of your net earnings (a contribution that would be deductible as a business expense). Your total contribution, employee plus employer, can’t exceed $53,000 in 2015.

Individual 401(k)s are somewhat more complicated to set up and administer than Simplified Employee Pensions (SEPs) or Savings Incentive Match Plan for Employees (SIMPLEs). But many discount brokerages are eager to help you with the paperwork and have low or no set-up costs.

You have many other ways as a self-employed person to reduce your taxes, but the rules can be complicated. A certified public accountant or an enrolled agent can help advise you of your options. You can get referrals to tax professionals from the American Assn. of CPAs at http://www.aicpa.org and the National Assn. of Enrolled Agents at http://www.naea.org.

Q&A: Breaking even with Social Security

Dear Liz: This is in regard to the reader who created a spreadsheet that he thought showed the advantage of taking Social Security early. I retired at age 62 and am now 69 and have not yet started drawing my benefits. I have never done a spreadsheet to determine the relative advantage in waiting to draw on my personal benefits; I’ve simply assumed there is no advantage or disadvantage, actuarially. That is, whether I took benefits beginning at age 62 or waited, as I’m doing, the total amount I would receive would be the same if I lived an average life expectancy. Given the fact that my wife would be drawing my benefit if I die first, however, it’s clear that my waiting to age 70 to draw my benefits works to our joint advantage. Am I right?

Answer: In the past, the Social Security Administration advised people that they would receive roughly the same amount by starting reduced benefits early as they would by waiting to receive larger amounts, assuming they lived an average life expectancy.

These days, though, longer life expectancies at age 65 mean that most people will live past the “break even” point where waiting for enhanced benefits results in more money over a lifetime than starting early. The break-even point is in one’s late 70s. Men have a 60% chance of living to age 80 and women have a 71% chance, according to the Society of Actuaries.

When you’re married, you need to think in terms of two life expectancies, because the chances are even better that one of you will live past the break-even point — perhaps well beyond.

With married couples, there’s an 88% chance at least one of you will live to 80, a 72% chance of at least one spouse living to 85 and a 45% chance one will live to 90.

Because a surviving spouse will have to get by on just one Social Security check — either her own or one equal to what her spouse was getting — maximizing at least one benefit makes a lot of sense.

There’s also the idea that Social Security should be used as a kind of longevity insurance. The longer you live, the more likely you are to use up all your other assets, so a bigger check can mean a much better standard of living.

Q&A: Filing and Suspending Social Security

Dear Liz: I was told by a staff person at our Social Security office that because I am seven years older than my husband (he is 58, I am 65), the “file and suspend” wouldn’t work for me and that because I am waiting until 70 to claim benefits, it was a non-issue.

Is that correct? How does the “lump sum” option figure into the equation? How quickly would I have to file and suspend not to be penalized for the process?

Answer: The “file and suspend” option allows you to file for your Social Security benefit and then immediately suspend that application.

The suspension means your benefit continues to earn delayed retirement credits that boost the amount of your checks 8% each year until age 70, when your benefit reaches its maximum. The file and suspend option is available only once you’ve reached your full retirement age (which is currently 66 but which is rising to 67 for those born in 1960 or later).

There are two main reasons to file and suspend. The first is to allow your spouse to claim spousal benefits based on your work record. The second is to give you the option to change your mind.

If you file and suspend, then discover you need the money, you can either start benefits at the larger amount you’ve earned with delayed retirement credits, or give up those credits and instead receive a lump sum payment of benefits back to the date you suspended your application.

There’s no reason for you to file and suspend for spousal benefits since your husband would have to be 62 before he could file for those checks. By that time, as the Social Security representative points out, you’ll be close to age 70, when you plan to start your benefit anyway.

You could still file and suspend as an insurance strategy — in case you need the money later. If that’s your plan, then doing so at your full retirement age of 66 would give you the option of requesting the largest possible lump sum if you do change your mind.

Decisions about when to start Social Security benefits and how to coordinate benefits when you’re married (or divorced, or widowed) can be extremely complex.

Please read the information the AARP provides on its site about maximizing Social Security benefits and consider using one of the available calculators to explore your options. AARP and T. Rowe Price have free calculators, and you can find more sophisticated options for $40 at sites including MaximizeMySocialSecurity.com and SocialSecurityChoices.com.

Q&A: Delaying Social Security benefits

Dear Liz: If I retire at 66 but don’t collect my Social Security until 70, will my benefit increase or stay the same since I wouldn’t be working? I can’t find this answer anywhere! Thanks so much.

Answer: Your benefit will increase eight percent each year you put off starting benefits between your full retirement age (currently 66, but rising to 67) and age 70. You get those “delayed retirement credits” whether or not you continue working.

Many people erroneously think the two decisions—when to quit work and when to start Social Security—have to be linked. In fact, they can be entirely separate.

You can retire years before you start Social Security and vice versa. Given the built-in benefit increase for waiting to begin Social Security checks, it often makes sense to tap other retirement money if you can while you wait for your check to max out.

Q&A: “File and suspend” Social Security

Dear Liz: You’ve been writing about the “file and suspend” option that allows you to delay taking Social Security while still reserving the ability to get a lump sum if you later change your mind.

If I file and suspend but choose not to take a lump sum before my benefit maxes out at 70, what happens to those funds? What happens to those funds if I die before 70?

Answer: Remember that Social Security is a pay-as-you-go program. The Social Security taxes you pay aren’t piled up in some kind of account, waiting for you to retire. Your taxes pay current retirees’ benefits, just as future workers’ taxes will pay yours.

When you delay starting Social Security, you’re rewarded with a potentially larger check each year you put off claiming until age 70. Your benefit grows by about 7% each year between age 62 and your full retirement age, which is currently 66.

Between full retirement age and 70, your benefit grows at 8% each year in what’s called “delayed retirement credits.”

If you file and suspend at your full retirement age, then change your mind, you can get a lump sum equal to all those checks you passed up since you filed. However, you lose the 8% delayed retirement credits you could have otherwise claimed.

Your benefit is reset to the lower amount you would have received at full retirement age, and that’s the benefit on which all future cost-of-living calculations would be made.

Should you die after filing and suspending, your surviving spouse would be able to benefit from those delayed retirement credits. His survivor’s benefit would be equal to what you could have claimed as of the date of your death.

Q&A: Waiting on Social Security

Dear Liz: I started Social Security at 62 and did the spreadsheet myself showing the break-even point. I would have to be 80 before the graphs even cross.

You, and others, have to stop that business about waiting on Social Security if you can. My own mother lived to 90 and it is about quality of life, not collecting lots from the government.

Answer: Exactly. And since you have longevity in the family, you especially should have paid better attention to the message about the importance of delaying benefits.

If your mother started benefits at 62, or ended up living on a survivor’s benefit from a husband who started early, then her checks were 30% to 50% smaller than they could have been. That difference can be especially crucial in a person’s later years, when she’s far more likely to have outlived her other assets and need the additional money.

Remember that the decision to claim Social Security is separate from the decision to retire. People can retire early and draw from other accounts while putting off Social Security to maximize their checks.

Most people who try to do the math on spreadsheets fail to factor in the effects of inflation and taxes, among other factors.

You can get better calculations from one of the free calculators, such as the ones at AARP and T. Rowe Price. You can find a more robust calculator for about $40 at MaximizeMySocialSecurity.com and SocialSecurityChoices.com.

Another option is to read the recent bestseller published by Simon & Schuster: “Get What’s Yours: The Secrets to Maxing Out Your Social Security.”

Q&A: 401(k) employer limits

Dear Liz: My company doesn’t allow us to contribute more than 50% of our paycheck to our 401(k). This limits my contribution to far less than the IRS’ $18,000 annual limit because I’m low paid.

How can I tackle this situation, as I would want to contribute more but am being constrained by the 50% contribution cap?

Answer: Your zeal to save for retirement is admirable. Your company may not have anticipated that anyone in your situation would be able to save so much, so consider simply asking if the limit can be raised.

You can explore other avenues as well, such as contributing to an IRA or a Roth IRA. Many people incorrectly believe they can’t contribute to these individual retirement accounts if they have a workplace plan, but that’s not true.

You can contribute up to $5,500 to a Roth (plus a $1,000 catch-up contribution if you’re 50 or older) if your income is below certain limits. The ability to contribute is reduced between modified adjusted gross incomes of $116,000 and $131,000 for single filers and $183,000 and $193,000 for marrieds filing jointly. Alternatively, you can contribute $5,500 (plus the $1,000 catch-up contribution) to an IRA regardless of your income, although your ability to deduct your contribution if you have a workplace plan is phased out for incomes between $61,000 and $71,000 if single and $98,000 to $118,000 for marrieds.

Q&A: “File and suspend”

Dear Liz: You recently encouraged a reader to listen to his financial advisor, who wanted him to file for his Social Security benefit at his full retirement age of 66 but then suspend the application until his benefit maxes out at age 70.

Another good feature of this “file and suspend” maneuver is the ability to ask for all the unpaid benefits in a single lump sum in the event one develops a terminal illness or needs funds for some other exigent circumstance, such as long-term care. The potential lump sum “back pay” can be a pretty good insurance policy while waiting for age 70.

Answer: Thanks for highlighting this important feature. Many people who are on the fence about delaying Social Security don’t understand that their decision is reversible — as long as they wait until their full retirement age to file.

At that point, they have the option to file and suspend. If they later change their minds, they can request a lump sum for all the benefits back to the date they filed.

They lose any “delayed retirement credits” from waiting — in other words, their benefit is reset to what it would have been had it started at full retirement age — but they get a big chunk of cash when they may need it most.

People who file before their full retirement age, which is currently 66 and rising to 67 for people born in 1960 and later, don’t have the option to file and suspend.