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Claiming Social Security is one of the most significant financial decisions retirees face. However, many people rely on generalized advice, leading them to mistime their Social Security benefits and miss out on maximizing their income. As a Certified Financial Planner with over a decade of experience and thousands of hours of consultations with retirees, I frequently see these three signs of poor Social Security timing.
Sign 1: Ignoring YOUR Financial Story
The first sign that you might be timing your Social Security completely wrong is ignoring your personal financial story. Social Security should not be viewed in isolation; it is just one component of your overall retirement plan. You need to consider other income streams, assets, and financial obligations when deciding when to claim your benefits.
Why It's Important
Social Security is a form of income, and income affects your tax bracket. Depending on your unique situation, claiming Social Security at the wrong time can cost you thousands of extra dollars in taxes. For instance, if you have substantial assets in a 401(k), Required Minimum Distributions (RMDs) will force you to take income from these accounts, which could push you into a higher tax bracket.
Example Scenario
Consider Susan, whose Social Security benefit at her Full Retirement Age (FRA) is $2,500 per month. If she claims at 62 and lives to 90, she receives a total of $588,000. If she waits until her FRA, she gets $690,000—a $102,000 difference. However, Susan also has a few million dollars in her 401(k). By waiting to claim Social Security, she could potentially use her 401(k) funds at a lower tax bracket before RMDs kick in, reducing her overall tax burden.
What You Can Do
To avoid this mistake, coordinate your Social Security benefits with your personal financial story. Consider the "order of withdrawals" from different account types (taxable, tax-deferred, and tax-free accounts) and how Social Security fits into this strategy. Generally, people withdraw from taxable accounts first, tax-deferred accounts second, and tax-free accounts last. However, this isn't a one-size-fits-all approach, and you should tailor it to your specific situation.
Sign 2: Misunderstanding How Benefit Calculations Work
Many people misunderstand how their Social Security benefits are calculated, leading to incorrect assumptions about the amount they will receive. Your benefit is based on your work history, earnings, and the age at which you claim.
Why It's Important
Misinterpreting your benefit amount can lead to several issues:
- Underestimating your benefit could result in a lower income than expected, forcing you to restrict your spending.
- Overestimating your benefit might lead to delaying your claim unnecessarily, which could reduce the total amount you receive if you don't live long enough to benefit from the delay.
- Missing out on opportunities to boost your benefit through additional contributions.
Key Factors
- Years of Work: Social Security uses your top 35 years of work to calculate your benefit. If you have less than 35 years, working an extra year or two could significantly increase your benefit.
- Salary Level: Your contributions to Social Security are based on your salary. The maximum salary considered for 2024 is $168,600. Ensuring you're maximizing your contributions can boost your benefit.
- Future Earnings: Your estimated future benefit assumes you will earn the same salary as the previous year. Earning less will reduce your benefit, while earning more, up to the maximum limit, will increase it.
How to Calculate Your Benefit
To calculate your benefit, you'll need your earnings record, indexed for inflation, and then calculate your Average Indexed Monthly Earnings (AIME). This involves applying a benefits formula and adjusting for your age. Although this process might seem complex, understanding it can help you avoid surprises when you receive your first benefit check.
Sign 3: Misinterpreting Spousal and Survivor Benefits
Spousal and survivor benefits are crucial aspects of Social Security that are often misunderstood. These benefits can significantly impact the income of the surviving spouse.
What They Are
Spousal Benefits: These are based on the work history of your spouse while they are alive and can be up to 50% of their Primary Insurance Amount (PIA).
Survivor Benefits: These are based on the work history of your deceased spouse and can be up to 100% of their PIA.
Why It's Important
Surviving spouses often face a reduction in income when they switch from spousal to survivor benefits. While they receive 100% of the deceased spouse's benefit, they lose the additional 50% spousal benefit, resulting in a significant income drop.
Example Scenario
Consider two couples with the same benefit amounts:
Couple A: Claims benefits at ages 62 and 70.
Couple B: Both claim benefits at age 62.
When Couple A turns 80, they receive $83,000 per year with inflation, while the surviving spouse's income drops to $69,000—a $14,000 difference. Couple B, on the other hand, receives only $68,000 per year, with the surviving spouse's income dropping to $53,000—a $15,000 difference. Maximizing the higher earner's benefit can create a significant advantage for the surviving spouse.
Conclusion
Understanding these three signs can help you avoid common mistakes when timing your Social Security benefits. By coordinating your benefits with your personal financial story, understanding how benefits are calculated, and properly interpreting spousal and survivor benefits, you can maximize your Social Security income and reduce your tax burden.
If you want to ensure you are making the best decisions for your retirement, consider consulting with a team of experts who can provide personalized advice tailored to your specific situation.
Click here to watch the full Youtube video that provides a full rundown of this topic!
