It’s not often that the federal budget deals with the nitty-gritty of personal-finance strategies for retirement. But this intriguing statement is buried deep inside the fiscal 2015 budget that President Obama released in March:
“In addition, the Budget proposes to eliminate aggressive Social Security claiming strategies, which allow upper-income beneficiaries to manipulate the timing of collection of Social Security benefits in order to maximize delayed retirement credits.”
The statement is a bit opaque, but when I asked the White House about this for a Reuters column, an official confirmed that the target is a somewhat obscure Social Security benefit-claiming strategy known as file-and-suspend. It’s a variation on the more straightforward strategy of delayed filing to earn a higher monthly benefit down the road. Mainly, it permits married couples to have their cake and eat it too–they can earn credits for delayed filing and bring in some Social Security income while they wait.
The White House assertion that file-and-suspend is being used exclusively by high-income households to game the system is debatable. A study by the Center for Retirement Research at Boston College found that 46% of file-and-suspend benefits flows to the top 40% of households, measured by wealth. These households certainly are more likely to work with financial advisors, who often help execute the strategy. File-and-suspend also has become a favorite strategy for online services, such as SocialSecuritySolutions.com, that help claimers maximize benefits. And wealthier households have other financial resources that can be spent to meet living expenses while they wait to receive Social Security.
On the other hand, any type of delayed claiming strategy will benefit lower-income households most because they are most reliant on Social Security as a source of replacement income in retirement. File-and-suspend definitely isn’t a loophole; it’s completely legal under the Senior Citizens’ Freedom to Work Act of 2000. The main point of the law was to give people incentives to work longer by allowing them to work and receive full Social Security benefits after they have reached their full retirement age, or FRA.
The White House proposal would require congressional action, so don’t expect changes anytime soon. But the shot across the bow of file-and-suspend makes this a good time to look at how the strategy works.
A Delaying Tactic
First, let’s review the basics of delayed filing. Social Security benefits are calculated using a formula called the primary insurance amount, or PIA. Claimants who wait to start Social Security until their FRA (currently 66) receive 100% of PIA; taking benefits at 62, the first year of eligibility, gets them 75% of PIA. By waiting until age 70, they’ll receive 132% of the PIA, and those benefits are enhanced by an annual cost-of-living adjustment, which is added in for years of delayed filing.
What’s the downside? First, you’re forgoing income in the early years. And some claimants worry that they won’t live long enough to come out ahead on lifetime benefits. But I think the break-even discussion misses several important points:
- Social Security is designed to provide insurance against longevity risk, not as a saving or asset-accumulation vehicle. The name of the game is boosting annual income, no matter how long you live; this is especially valuable at advanced ages, when you’re most likely to have exhausted other funds.
- Many of us underestimate our likely longevity. A Society of Actuaries survey last year found that 40% of adults underestimate their likely average longevity by five years or more; 20% were too pessimistic by two to four years.
- Couples should make filing decisions based on their combined lifetime benefit, not just what they’re likely to get as individuals. The odds of one spouse living to an advanced age are very high; the Social Security Administration reports that for a couple with above-average health, there’s a 60% chance one of them will live to age 90.
How File-and-Suspend Works
There are several ways to use file-and-suspend, but typically it’s a couples strategy.
The spouse with the higher PIA–typically the man–files for benefits at his FRA, then immediately files a notice to suspend payment of those benefits. That permits the lower-PIA spouse to file for a spousal benefit, which is equal to half the husband’s benefit.
That gets some income flowing to the household while the husband continues to accrue higher benefits until he files to start payments, perhaps as late as age 70; the wife then converts to her own full benefit. (Note: The spouse can convert to her full benefit only if she waits until her FRA to file for a spousal benefit.)
The couple receives higher individual benefits for the rest of their lives. If the husband dies first (that’s usually the case), the widow then converts to a survivor benefit, equal to 100% of her spouse’s benefit.
I discussed file-and-suspend at Morningstar’s 2013 Individual Investor Conference with Mary Beth Franklin, a columnist for Investment News with deep expertise on Social Security. You can listen to that discussion here, starting around 21:55 in the video.
How valuable is file-and-suspend as a benefit strategy? Let’s run a hypothetical example, courtesy of the T. Rowe Price Social Security Benefits Estimator. (You can run your own numbers at no charge using this online tool, or using the tool on the AARP website).
David and Barbara are both turning 66 this year and plan to file for Social Security benefits. We’ll assume his PIA at FRA is $2,500, and hers is $1,800. Further assuming that David lives to age 83, and Barbara to 95, they can expect cumulative lifetime benefits of $1,214,176.
Now assume that David files and suspends at age 66, waiting to activate his benefits until age 70. Barbara files for a spousal benefit at 66, which brings in $1,250 in monthly income; she converts to her own full benefit at 70. Their cumulative lifetime benefit jumps to $1,377,456–a gain of $163,280.
Just as important, Barbara’s delayed filing for her own benefit to age 70 gives her a huge income boost in the late years of life, when many elderly women tend to run out of money. At age 94, she will have $38,000 in annual Social Security income–$9,000 more than if she had simply filed for benefits at age 66.
There are a couple of other variations on file-and-suspend. Let’s say you needed income at age 62 because of a job loss or other financial setback; it’s possible to file early, suspend benefits at FRA, and restart them at age 70. You’d still have reduced income from the early filing, but suspending from age 66 to 70 would allow you to build additional credits.
Finally, individuals can use file-and-suspend sort of as an insurance policy against the risk that a delayed filing decision won’t work in their favor. Let’s say you’re in good health at your FRA and decide to delay to age 70–but then encounter a health problem at age 68 that leads you to conclude you’d have been better off claiming earlier. If you had executed a file-and-suspend at FRA, you could now request a full or partial lump-sum payment for the period that you suspended benefits, though you’d forfeit any delayed-benefit credits for that period of time.
File-and-suspend isn’t likely to disappear anytime soon, but Social Security does face long-term financial challenges: The combined retirement and disability trust fund is expected to be exhausted in 2033 absent any reforms. Social Security would then be able to pay 77% of scheduled benefits. The Social Security Administration doesn’t have reliable data on how much the strategy is costing the system, but file-and-suspend reform could become part of a larger Social Security reform package down the road.
Even so, past Social Security reforms have always been implemented gradually, which suggests that even if file-and-suspend were prohibited in the future, current beneficiaries would be grandfathered.
“My fear is that both advisors and consumers will think impending change will impact them and their claiming strategy,” says William Meyer, co-founder of SocialSecuritySolutions.com. “We all know the system needs to change, but it is unlikely any changes will impact individuals that are nearing retirement. The key is doing an evaluation on your situation and then thinking about how future change might impact you.”