How the new Social Security rules in 2016 create opportunities in 2017
by David Freitag, CLU, ChFC, CRPC and Bruce Tannahill, JD, CPA
Mr. Freitag & Mr. Tannahill are both affiliated with Mass Mutual, Springfield, Mass.Visit www.massmutual.com
Although the Bipartisan Budget Act was signed into law on November 2, 2015, the implementation of its changes to Social Security filing strategies actually started in 2016.
These changes represented a major upheaval to Social Security planning strategies that have been part of the system since the year 2000. Although there were many changes made to different parts of the Social Security filing rules, the major target of the new law focused on the popular “File and Suspend” strategy and the “Restricted Filing” strategy.
Old Law v. New Law
As a quick reminder, here is a summary of these two provisions found in the old law:
- The “File and Suspend” strategy allowed a worker to suspend his or her benefit at full retirement age and earn delayed retirement credits until age 70. At the same time the use of this strategy opened a window of opportunity for the worker’s spouse. At full retirement age, the worker’s spouse could collect a “spousal benefit” and allow their own benefit to earn delayed retirement credits by making the “Restricted Filing” discussed below. The net result of this strategy, which became a favorite for people with long longevity projections, was a potential 32% or 24% increase in Social Security benefits starting at age 70 for both spouses while one spouse collected three to four years of spousal benefits. The “File and Suspend” strategy for many couples was the golden ring method for claiming Social Security benefits.
- The” Restricted Filing” strategy allowed a worker, at full retirement age, to file for spousal benefits and at the same time continue to earn delayed retirement credits of 8% per year on their own record. “Restricted Filing” could not be elected until the worker reached full retirement age. This strategy is somewhat similar to “File and Suspend” but it only allows one person to recognize income while earning delayed retirement credits. For the “Restricted Filing” to work, one spouse has to be collecting benefits first.
For the long term, both of these filing strategies are now only found in the history books filed under a dusty category called “extinct.”
Grandfather Provisions
However, there were a few major grandfather provisions included in the new law to make these changes a little less onerous. These grandfather provisions effectively divided the entire population of workers, who are part of the Social Security system, into age based categories or tiers.
Workers who are currently collecting benefits using a “file and suspend” or “restricted filing” strategy are not impacted by the new changes to the law. Also widows or widowers are specifically excluded from the new changes.
- Tier #1 — Grandfather Provision – Workers who turned 66 on or before April 29, 2016, retained the ability to “File and Suspend”. However, if they did not file and suspend by that date, this option vanished. “File and Suspend” for everyone else is now gone.
- Tier #2 — Grandfather Provision – For workers who tuned 62 on or before January 1, 2016, the ability to do a “Restricted Filing” remains an option. As a reminder, for a worker to do a “Restricted Filing” his or her spouse must have filed for their own benefits first. Also a worker cannot do a “Restricted Filing” until full retirement age.
The big advantage of “Restricted Filing” is that the worker who files “Restricted” can collect spousal benefits while they earn delayed retirement credits on their own record. The restricted filing option helps the worker by creating an important new source of income between the ages of 66 and 70.
“Restricted Filing” can also help the surviving spouse. When one passes away, the survivor will receive the higher of the two benefits for the rest of his or her life. These survivor benefits will include all of the earned delayed retirement credits plus any Cost of Living Adjustments (COLAs) made while they were both alive and collecting.
Quick math shows that this window to file a Restricted Application will be open until 2023 depending on when the worker turns age 70. However, after that time, it too will vanish and be forever lost to workers planning for retirement.
- Tier #3 — NO Grandfather Provision – Here is the real impact of the new law: For all workers under the age of 62 on January 1, 2016 and paying FICA taxes, these flexible filing strategies are gone. Younger workers cannot file and suspend and they cannot file a restricted application. The people in Tier #3 represent most of the active workers in the United States. These younger workers now have just one filing option to consider – When to Start Taking Benefits. Although this does not sound all that hard, the decision can be overwhelming when you consider that a married couple approaching age 62 has 81 different age combinations available to them.
Starting Ages for Benefits | Projected Cumulative Value | Difference |
Bob age 70 – Mary age 70 | $1,967,000 | |
Bob age 66 – Mary age 66 | $1,740,000 | $227,000 Less |
Bob age 62 – Mary age 62 | $1,471,000 | $496,000 Less |
Starting When you run modeling software to see the relative payout of taking benefit at 62, at full retirement age, or at the latest age of 70, it is shocking to see the difference in these strategies. Take a look at this sample projection modeled for a married couple, Bob and Mary. Let’s assume that both just turned 60 years old in 2016. Bob and Mary are in good health and are comfortable with a life expectancy forecast to 90 for Bob and 93 for Mary. Let’s also assume an inflation rate of 1.5% per year over the course of their retirement. Bob’s projected Social Security Benefit at his full retirement age is $2,400. Mary’s projected Social Security Benefit at her full retirement age is $2,000.
As this model suggests (see chart above), Bob and Mary are not likely to take their benefits at age 62 even if they retired at that early age. It is hard to walk away from almost $500,000 in benefits.
It is possible that Bob and Mary are planning to wait until their full retirement age, 66 and 4 months, to take their benefits. Yet starting at full retirement age leaves over $227,000 in lost benefits when compared to taking their money at age 70.
Great Opportunity for Tier #3 Workers
To get the most out of Social Security, if you have average to better than average life expectancy, younger workers need to find ways to take benefits later in life. The power of the delayed retirement credit is easy to see. What is not easy to see is the road map that points the way to taking benefits later in retirement.
Clients are going to need cash between age 62 and age 70 to take advantage of the higher Social Security payout options. However, if they wait until age 60 or 62 to discover that the power of Social Security is reserved to those who wait, it may be just too late.
The effect of the Bipartisan Budget Act is to shift more and more responsibility for retirement security back to the worker. The traditional three legs of the retirement model are now fundamentally changed. This news is something that younger clients need to know today.
The changes made to Social Security in 2015, which went into effect in 2016, have ushered in a new opportunity to urgently extend the retirement savings discussion to younger workers. That means younger workers must consider putting more money into 401(k) plans and other employer-sponsored retirement plans as well as consider other retirement income strategies that may include life insurance, and annuities and non-qualified investments. It also means starting to plan for retirement sooner than ever before.
As it turns out, 2016 is a landmark year in the financial services industry and a prime opportunity to discuss how recent changes to Social Security filing strategies can work for clients’ best interests in their retirement income plans. ◊
