The End of Social Security Loopholes: What Now?
DEC. 4, 2015
For years, retirees have been able to squeeze tens of thousands of extra dollars from Social Security using two special tactics. Though they went by gimmicky names like "claim benefits now, claim more later," these strategies were perfectly legal.
But that bonanza is about to end. Congress eliminated these techniques in October as part of the federal budget bill.
Married couples were the big beneficiaries of these strategies. So those who planned on using them and now cannot will need to rethink their overall approach. They may be tempted to begin collecting sooner because the extra money generated by these tactics will soon disappear for many of them.
But even under the new rules, the basic tenet for when to claim Social Security remains: Healthy people nearing retirement should often wait as long as they can to collect, particularly if they are the higher-earning spouse. Though retirees can claim benefits starting at age 62, the payoff for waiting can be huge, especially if they consider the benefit as a way to hedge against outliving their money.
Those who wait until they are 70 to collect — and only 2.2 percent of beneficiaries did in 2014 — will end up with a monthly check that is 76 percent more than if they started the moment they became eligible.
"The big game is still being patient," said Laurence Kotlikoff, a professor of economics at Boston University, co-author of a book on Social Security strategies and creator of MaximizeMySocialSecurity.com, a software program that helps users determine when to claim benefits.
There is still an opportunity for some couples and divorced people to collect extra money under the old rules, so they may want to evaluate whether they are eligible before the final window closes.
Simply put, the strategies about to be eliminated generally allowed individuals to collect spousal benefits while their own benefits continued to grow by 8 percent each year. This became possible with successive policy changes as well as a law passed in 2000 that enabled retirees who were already collecting benefits to turn them off and go back to work. Turning off the benefits allowed them to grow again.
Over time, however, some people figured out how to exploit the 2000 law and the other changes to squeeze more money from the program. One strategy allowed married retirees to file for benefits at their full retirement age, immediately suspend them, then begin collecting when they reached their highest value. That let the other spouse collect a spousal benefit.
The second approach allowed married people who reached their full retirement age — generally 66 for the current crop of retirees — to file what was known as a restricted application. That let retirees collect only a spousal benefit, while their own benefits continued to increase.
Under the new rules, retirees can collect only the larger benefits — spousal or their own — but not both. As a result, they may lose anywhere from $10,000 to more than $60,000, depending on the size of a couple's spousal benefits.
The Social Security Administration contended, and Congress ultimately agreed, that the various policy changes created unintended loopholes that were being used by those wealthy enough to work with knowledgeable financial pros. But critics of the congressional change, along with some financial planners, have said the strategies also benefited lower- and middle-income retirees who truly needed the extra money. Either way, many retirees didn't know these complex techniques were even possible.
"You really had to be in the know to actually use them," said Alicia Munnell, director of the Center for Retirement Research at Boston College, who was glad to see the tactics eliminated. "So it became an unfair system."
Still, these techniques did make the conventional advice — to delay taking Social Security — more palatable because they did permit couples to receive something while they waited. Now, individuals who are eligible for spousal benefits will be deemed to have filed for their own retirement benefit as well. So they cannot claim one and then switch to a higher benefit later.
As a result, some couples may be tempted to file sooner under the new rules because the arithmetic changes. Now, as they consider whether to wait to collect the higher benefit, retirees may have to think harder about their life expectancy.
"It takes longer for a delayed strategy to be superior to one where you claim early," said William Meyer, founder of Social Security Solutions, a tool that helps users decide how to optimize their benefits. "Many people under the new rules would be better off if they claim at full retirement age instead of delaying until 70. Of course, if you are healthy and could possibly live a long life, the delay strategy is best since it hedges longevity risk."
Take, for instance, a married couple with strong longevity genes: They are each entitled to $2,000 in monthly benefits at their full retirement age, or 66, and are still eligible for the "file and suspend" strategy that is being eliminated. One of the spouses filed and suspended the benefit until age 70, while the other collected spousal benefits, then switched to his or her own benefit, also at age 70.
Using this approach, they would have to live until 79 years and eight months before they collectively received more money than if they both started collecting benefits at age 66, according to calculations by Lars Phillips, an associate adviser at Avier Wealth Advisors in Bellevue, Wash.
But if they were a born a year later — making them ineligible to file and suspend — the math changes. In that case, if they both wanted to delay their benefits until 70, they would have to collect benefits for nearly three more years — or until they were 82 years and seven months — to collect the same amount as if they both began to collect at age 66.
Figuring out the best strategy is difficult because few retirees know how long they will live. But the fact remains, even now, that it is largely impossible to buy an annuity from an insurer that is as cheap as delaying Social Security — if you think about the money left on the table as payment for the higher monthly check. It's a cheap hedge against longevity.
And that's why many financial advisers say they are still big proponents of having the higher-earning spouse delay benefits as long as possible, while the lower-earning spouse collects far earlier.
So what was the total damage to the taxpayer for not closing these loopholes earlier?
"It is highly probable that one spouse will live into their 90s, which makes it a good bet to delay the higher earner," explained Michael Kitces, director of planning research at Pinnacle Advisory Group, who wrote about the changes on his blog.
That's because both spouses benefit as long as either of them is alive, because that's the benefit the survivor will keep. Mr. Kitces said it rarely paid to have both spouses wait until they're 70, however, because it is less likely that both spouses will stay alive long enough to reach the so-called break-even point — when they receive more money as a result of collecting a larger check at 70).
Naturally, a a couple's optimal strategy will vary based on their age difference, the size of their benefits or perhaps whether they can still get under the wire and take advantage of the old rules.
Who falls under those old rules? Retirees who are already receiving benefits under either approach will continue to receive them.
As for filing and suspending, the higher earner, or the spouse who is likely to file and suspend, must be 66 before next May. The higher-earning spouse also needs to file and suspend before April 30, 2016, and it's probably wise not to wait until the last minute.
Individuals who want to file a restricted application for only spousal benefits must be 62 or older by Jan. 1, 2016 — or those born Jan. 1, 1954, or earlier. Those retirees are grandfathered in; they can collect those benefits once they reach their full retirement age, even if that is several years from now. (Those who turn 62 after Jan. 1 next year are no longer eligible.)
Restricted applications "would make sense if your spouse is receiving benefits when you reach full retirement age and you file for your spousal benefits on their record while waiting for your own until age 70," said Lesley J. Brey, a financial planner in Honolulu.
But just because someone is eligible doesn't necessarily mean these approaches will always make sense. Filing and suspending could harm people in certain circumstances.
The new rules do simplify matters by limiting your choices, in one sense. But it's still a complicated yet critical decision, which is why it is often advisable to work with financial planners who charge for their time or advice (and not what they sell). There are also several software programs that can provide guidance.
"It is not always obvious," Mr. Meyer said, "which strategy is the best.
Posted by: sarah_oz@yahoo.com
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