Q&A: Don’t rush to collect Social Security

Dear Liz: I would like you to explain to us retirees why we should delay taking Social Security.

I have two tax preparers — and other people — who say delaying is a terrible idea. I’m in my 20th year of collecting Social Security, and I can assure you that people who delay are making a dreadful mistake. Please check this out!

Answer: Your tax preparers may have had a point 20 years ago, but a lot has changed since then, including life expectancies and prevailing interest rates. It’s unfortunate if your advisors haven’t kept up with copious research showing that delaying Social Security makes sense for most recipients.

One issue of particular interest to tax pros is the “tax torpedo.” That’s a sharp rise and then fall in the marginal tax rate caused by taxation of Social Security benefits. Researchers found the tax torpedo could nearly double the marginal tax rate for many middle-income families. People in the 22% federal tax bracket, for example, could see their marginal tax rate jump to 40% on a portion of their income.

Two decades ago, this would have been an issue for fewer taxpayers because most did not owe income tax on their Social Security benefits. Now more than half pay taxes on their benefits because Congress hasn’t updated certain income limits to reflect inflation.

The researchers found that delaying the start of benefits until age 70 and tapping retirement funds instead could reduce the tax torpedo’s effect. This approach not only maximizes Social Security benefits but also reduces the minimum amounts that must be distributed starting at age 70½. For more details, you can point your tax advisors to the July 2018 issue of the Journal of Financial Planning.

The National Bureau of Economic Research also has numerous papers on Social Security-claiming strategies, including “Recent Changes in the Gains from Delaying Social Security,” “Leaving Big Money on the Table: Arbitrage Opportunities in Delaying Social Security,” “The Power of Working Longer” and “The Decision to Delay Social Security Benefits: Theory and Evidence.”

Q&A: Don’t fall for these common Social Security misconceptions

Dear Liz: I decided to start taking Social Security benefits this summer when I turned 62. My monthly benefit is $1,809. My wife turned 62 at the end of last year and started her benefit of $841 a month. I just accepted an unexpected job offer that will pay me more than $130,000 a year. I suspect I should consider suspending my benefit at this point and work as many years with this company as possible. If I choose to suspend my benefits now and allow my benefits to remain suspended until my full retirement age of 66 years six months, I will pass up benefits of $112,000 over the next 4.5 years. Granted that amount will be overshadowed by the additional new income and the opportunity to contribute to a 401(k), but is it out of the question to continue my current benefit and just pay the 85% tax on the Social Security we receive each year in addition to our other income?

Answer: Social Security is complicated, so it’s not surprising that so many people get the details wrong. Unfortunately, those details can have a huge effect on financial well-being in retirement. The difference between the best claiming decisions and the worst can total more than $250,000, researchers have found.

Let’s start with the detail you need most: You don’t have the option right now of suspending your benefit. Only people who have reached their full retirement age can suspend. You can, however, withdraw an application within the first 12 months. You will have to pay back all the money you’ve received from Social Security, but then it will be as if you’d never applied. Your benefit can continue to grow by 5% to 8% each year until you restart your benefits or turn 70, whichever comes first.

Withdrawing your application is a good idea because otherwise your new job will offset all of your Social Security benefit.

Because you started Social Security early, you are subject to the earnings test and your benefit will be reduced by $1 for every $2 you earn over a certain limit, which in 2020 is $18,240. Your six-figure income would reduce your benefit to zero.

This earnings test disappears at full retirement age, and any money that was withheld because of it is added back into your benefit over time. In the meantime, however, you’ve given up the more valuable 5% to 8% growth in your benefit and reduced your survivor benefit as well.

Social Security taxation also works differently than what you’ve described. You never have to pay taxes equal to 85% of your benefit. If your income exceeds certain levels, then up to 85% of your benefit could be subject to taxation. (To illustrate, that means if you’re in the 10% federal tax bracket, you’d pay 10% on up to 85% of your benefit. It’s more complicated than that, but that may help you understand the difference between losing a huge chunk of your benefit and having to pay tax on a portion of it.)

Given all these complexities, it’s important for people to use a few Social Security claiming calculators before applying. Ideally, they also would consult a financial planner who’s been educated on Social Security claiming strategies.

Q&A: Finding income for widow and children

Dear Liz: You recently answered a question from someone about Social Security survivor benefits for her grandchildren. The young father who died had been paid under the table, which meant his employment didn’t qualify the children for survivor benefits. It’s a long shot, but perhaps the young man filed his taxes as if he were self-employed, in which case his employment would count toward Social Security’s requirements. If no returns were filed, perhaps the family could consider preparing and filing the returns for the last several years. That could trigger a tax bill, but the cost probably would be outweighed by the potential benefits to these young children.

Answer: That’s certainly an option worth exploring with a CPA or tax attorney, especially if the father had a bank account or some other way to document the cash he received.

As mentioned in the previous column, Social Security survivor benefits can be paid to the children of qualified deceased workers until the kids turn 18 (or 19, if they are still in high school full time), but the worker needs to have paid into Social Security a certain length of time. The children’s mother also might be eligible for benefits, if she was married to the father. As a widow caring for the deceased person’s minor children, she would be entitled to benefits until the youngest child turned 16.

Q&A: Social Security doesn’t prevent working

Dear Liz: I have a friend who is in her early 70s and earns income from her own business but she said that she also collects Social Security. How is this possible? I thought that a person cannot earn income from a job or self-employment while also collecting Social Security. Am I wrong?

Answer: Quite wrong.

Nothing prevents people from working while receiving Social Security. If they’re receiving benefits before their full retirement age — which is currently 66 — their checks are subject to the earnings test. That test reduces the amount they receive by $1 for every $2 they earn over a certain limit, which in 2019 was $17,640.

Once people reach full retirement age, the earnings test goes away and they no longer have to worry about its effect on their checks.

Q&A: Working past 70

Dear Liz: If I continue to work after 70, will Social Security taxes still be deducted from my check? I understand my benefits will cap out at 70, so why would I need to still pay into the fund?

Answer: Because Social Security is insurance, not a bank account.

And it may not be true that your benefit maxes out at 70, if you continue to work. It’s true that delayed retirement credits no longer increase your benefit if you delay starting Social Security past age 70. But as long as you continue working, you’re potentially growing your benefit.

Your Social Security check is based on your 35 highest-earning years, adjusted for inflation. If you make more in a current year than you made in one of those previous highest-earning years, the current year will be substituted for the earlier one. That in turn can increase your benefit. This can happen at any age, including after you start benefits.

You might not see much increase, of course, or any increase at all if you’ve earned a high income for a long time. If you exceeded the maximum income limits subject to Social Security taxation every year for 35 years, your benefit wouldn’t increase with additional work. (In 2019, for example, the maximum income limit is $132,900; you don’t pay Social Security tax on earnings above that level, although you continue to pay Medicare tax.)

On the other hand, your benefits won’t be stopped once you collect as much from the system as you paid in. You will continue receiving benefits for as long as you live, even if that amount far exceeds what you’ve paid in taxes. That’s insurance worth paying for.

Q&A: This nurse needs a Social Security checkup. Here’s how to check yours

Dear Liz: I’m a certified nurse midwife who is salaried. When we are fully staffed, I work 55 hours a week on average. If we cover extra shifts, we are paid a lump sum rather than hourly. (If we were paid hourly, it would work out to far less than minimum wage.) We are paid twice a month, but my pay stub shows that I only work 70 hours per pay period. I work almost that many hours in a single week! When I work extra shifts, it is reported on my check under “miscellaneous” with the lump sum listed. I asked our administrators about this and they just told me it wasn’t a big deal, but I’m not convinced that’s true. Do the hours reported on my paycheck affect my Social Security income later? I just don’t want to lose out on Social Security benefits when I work my butt off!

Answer: The hours you work don’t affect your future Social Security benefit, but your earnings do. At least they should. Your employer is supposed to report your full salary to Social Security, and to deduct the appropriate amount of Social Security tax from your paychecks. If your pay is underreported, your future benefits could be shortchanged.

Here’s a quick way to check if your earnings are being reported properly. On your paycheck, there should be a line that says either “Social Security,” “OASDI” or “FICA.” If the line says Social Security or FICA, the amount listed should be 6.2% of the money you earned for the pay period, up to a maximum annual amount of $8,239.80 for 2019. (There’s a ceiling on the amount of wages subject to Social Security taxes, which this year is $132,900.)

Some employers don’t break out Social Security taxes from Medicare taxes, and include them both in a line for FICA, which stands for Federal Insurance Contributions Act. The FICA amount should be your Social Security tax (6.2% of your earnings up to $132,900) plus 1.45% for Medicare. (There’s no cap, so all earnings are subject to the Medicare tax.)

If the tax amounts shown don’t include that “miscellaneous” lump sum, please call the IRS at 1-800-829-1040 to report the situation.

Q&A: Triggering the windfall elimination provision

Dear Liz: After working and paying into Social Security for more than 40 years, I took a city job at age 60. This job does not pay into Social Security and will afford me a small pension upon retirement in a few years (I’m now 64). Will this pension amount be deducted from my Social Security payments?

Answer: Normally, people who get pensions from jobs that didn’t pay into Social Security face the “windfall elimination provision,” which can reduce any Social Security benefits they may have earned. If, however, you have 30 or more years of “substantial earnings” from a job that paid into Social Security, then this provision does not apply. The amount that counts as “substantial earnings” varies by year; in 2019, it’s $24,675.

Q&A: Death doesn’t take a financial holiday. Here’s a cautionary tale

Dear Liz: My daughter has two children, ages 2 and 4. Recently the children’s father took his own life. He was 27. The job he worked as long as I knew him paid him in cash, so he didn’t pay into Social Security. Does this mean the children cannot receive survivor benefits from Social Security?

Answer: If the father never worked at a job that paid into Social Security, your grandchildren — and your daughter — won’t qualify for the survivor benefits they could have received had he been paid legally rather than under the table.

Their one hope is if he had a previous job that did pay into Social Security.

At 27, he would have needed at least six quarters of coverage to trigger survivor benefits, says Bill Meyer, founder of Social Security Solutions, a claiming strategies site.

The older a person is, the more quarters are needed to qualify for benefits, but no one needs more than 40 quarters. The amount of earnings required for a quarter of coverage is $1,360 in 2019. Once you earn $5,440, you’ve earned your four quarters for the year.

If the father had earned those six quarters, his death would trigger survivor benefits for his children that typically last until age 18 (or until 19, if they are still in high school full time). Your daughter also would be entitled to benefits until the younger child turned 16, because she’s caring for the deceased person’s minor children.

It’s possible this young man was paid under the table because he was not able to work legally in the U.S. If that’s the case, he and his family wouldn’t qualify for Social Security benefits even if payroll taxes had been deducted. If he opted for cash because he or his employer didn’t want to pay taxes, though, that was a choice that had expensive repercussions for the people he left behind.

Q&A: Why this widow can’t get her late husband’s Social Security benefit

Dear Liz: My husband passed away 10 years ago at age 66. I called then to see if I could collect Social Security, because he was receiving benefits when he died. Our daughter was still a minor, so she was able to collect survivor benefits until she turned 18. I was told I couldn’t collect benefits as I made too much money. (I asked what too much money was and they said around $14,000 annually.)

I am now thinking about retiring at age 66 or 67. I am a mid-career public school teacher, so I’ve been told the “windfall elimination provision” will wipe out my Social Security benefit. I had my own business and worked previously but am told I can’t receive the Social Security benefits that my husband earned, nor will I most likely receive much, if anything, from the Social Security contributions I made. My friends tell me this can’t possibly be right.

Answer: The information you received about Social Security was generally entirely correct.

Let’s start with the windfall elimination provision. If you receive a pension from a job that didn’t pay into Social Security, any Social Security benefit you get may be reduced but not eliminated. You can read more about how the windfall elimination provision works and why it was created at the Social Security Administration website, www.ssa.gov.

A related provision, the government pension offset, can wipe out any spousal or survivor benefit you might have otherwise received.

Before those provisions were enacted, people who had generous government pensions from jobs that didn’t pay into Social Security could get the same or larger benefits than people who had paid into the system throughout their lives. Critics of the provisions, however, say they can leave some low-wage government workers worse off.

Another provision that can reduce or wipe out Social Security benefits is called the earnings test. Before full retirement age, which is currently 66, any Social Security check you receive would be reduced by $1 for every $2 you earn over a certain amount ($17,640 in 2019). The amount was $14,100 from 2009 to 2011 and $14,640 in 2012, so that may have been why you remember the number $14,000.

So technically, you may have been eligible for a survivor’s benefit. Widows and widowers are eligible for survivor’s benefits starting at age 60, or age 50 if they’re disabled, or at any age if they’re caring for the dead person’s child who is under 16 or disabled. But it sounds as if any benefit you received would have been wiped out because of the earnings test.

Your situation is a perfect example of how complicated Social Security can get and how hard it can be to navigate the system without expert help. But even people with more straightforward situations can benefit from advice about how and when to file for benefits. Two of the better do-it-yourself options include Maximize My Social Security ($40) and Social Security Solutions ($19.95 for a basic version or $49.95 for one that allows you to compare scenarios). Or you can consult with a fee-only financial planner who has access to similar software and who can give you personalized advice.

Q&A: Benefits’ disappearance is no accident

Dear Liz: You recently indicated that restricted applications for Social Security spousal benefits are no longer available to people born on or after Jan. 2, 1954. Who is responsible for this change, and when was that enacted? Is there any way it can be reversed?

Answer: Congress is unlikely to revive what was widely seen as a loophole that allowed some people to take spousal benefits while their own benefits continued to grow.

Congress changed the rules with the Bipartisan Budget Act of 2015. As is typical with Social Security, the change didn’t affect people who were already at or near typical retirement age. So people who were 62 or older in 2015 are still allowed to file restricted applications when they reach their full retirement age of 66. They can collect spousal benefits while their own benefits accrue delayed retirement credits, as long as the other spouse is receiving his or her own retirement benefit. (Congress also ended “file and suspend,” which would have allowed one spouse to trigger benefits for the other without starting his or her own benefit.)