Can you spot the Social Security claiming mistakes?
Claiming spousal benefits under Social Security can be complicated. Here's a case study.
When helping clients think through their Social Security claiming strategies, it’s important to ask key questions, get the technical details right, apply the rules correctly and connect the dots to Medicare, working and taxes. There is a domino effect on client decisions they don’t realize.
A client situation
Tony is 68, born in 1953. He plans to claim Social Security at 70. His $2,800 primary insurance amount (PIA) will grow to about $3,800 with delayed retirement credits. His wife, Lucia, is 64, born in 1956. Her PIA is $1,000. She plans to wait until her full retirement age (FRA) to claim her spousal benefit.
Tony decided to retire at the end of June and pursue other activities. Some will provide limited income. Lucia is a freelance writer. She’ll continue to take on jobs for a few years.
Tony was leaving his large, corporate employer, which meant his group health insurance coverage was ending. He decided to sign up for Medicare right away. Lucia will use COBRA continuation insurance to bridge her temporary coverage gap.
Before locking in their final decisions, they wanted confirmation and validation from a financial advisor about their plans. Tony and Lucia had been do-it-yourselfers until now, but since retirement is such a big financial decision, they wanted some expert help.
The recommendation
The advisor they chose reviewed their Social Security plans and found an additional opportunity. Since Tony was born in 1953, he was still eligible to claim Social Security under the grandfathered “restricted application” — a loophole that allowed spouses to claim a spousal benefit today, then claim their maximum benefit at age 70. However, for Tony to claim his spousal benefit, Lucia needed to first claim her own Social Security benefit, even though she wasn’t at her FRA.
The advisor explained that although Lucia would get a reduced benefit now for claiming early, it will increase once Tony claims at 70. Then she will get half of his benefit payment. Therefore, this would be a relatively short-term reduction, and they would get unexpected extra cash from Social Security as they start their retirement years.
This is where things went off the track.
Getting the technical rules right
The advisor was correct that Tony can claim just a spousal benefit if Lucia claims her own benefit. Those born before Jan. 2, 1954, are still grandfathered into the old “restricted application” rules.
Lucia’s own benefit will be reduced 12%, to $880 per month. But, with Tony’s spousal benefit of $500 per month, it more than makes up her $120 monthly loss. This newfound $1,380 was a welcome “bonus.”
And it is temporary. Tony will switch to his own maximum benefit at 70, in two years. At that same time, Lucia is at her FRA, so she’ll get half of Tony’s $3,800, or $1,900, he advised them. Together, they’ll receive $5,700 per month in Social Security benefits.
And, by waiting until 70, Tony has provided the best layer of protection he can for Lucia, if he is the first to die.
They were very pleased with how this worked out, and Lucia applied for her early benefit. And then they called me. They were quite dismayed that I was not enthusiastic about this plan.
What went wrong/?
The first issue is that this couple will not get $1,380 in extra cash each month. They will both start Medicare this year. Part B premiums will come right off the top.
Unfortunately, the advisor failed to factor in Medicare. Nor did he take into account their modified adjusted gross income from two years ago. That’s the income Social Security will use to determine their Part B premium.
Turns out, they are a higher-income household. In their case, they fall into the second income-related monthly adjustment amount (IRMAA) tier. Each will be assessed a Part B premium of $297 per month, considerably higher than the standard $148.50. In addition, they will pay $31.80 per person per month for the Part D IRMAA.
That means their “newfound cash” will drop almost 50% to $722 per month. And the advisor didn’t mention their benefits would be taxed at their ordinary income tax rate.
And these aren’t even the most concerning issues. What else is missing from this analysis? More to come in part 2, next month.
