As you may be aware, Social Security (or the trust in which Social Security benefits go) will probably be insolvent or in default before those of us currently in our 30s and 40s reach retirement age. In fact, Barron’s states that “Social Security benefits will start to exceed the program’s costs in 2020, and the program will deplete its $2.9 trillion reserve fund in 2035.” Now personally, I don’t believe the government is going to allow Social Security to go bankrupt. However, I do believe that Full Retirement Age may be pushed back to 70. I also anticipate a Social Security tax increase across the board for all Americans. Yet, now is not the time to panic and start taking Social Security benefits early just because you’re afraid of losing any and all benefits in the future. Instead, it’s time to learn the facts about Social Security benefits and when you should start taking it if you own a business.
In order to understand Social Security benefits, there are three particular ages that matter.
The first age that matters is what the Social Security Administration refers to as your Full Retirement Age. In other words, this is the age you can start taking Social Security benefits without having any reduction in your benefit amount. Traditionally, full retirement age was 65. Yet, administrations in the past moved it from age 65 to age 67. Technically, full retirement age for those born before 1960 is 66 and so many months (depending on the year you were born), but for today’s conversation, let’s call full retirement age 67.
The other two ages that matter when it comes to taking your Social Security benefits are your bookend ages. You can start taking Social Security Income as early as age 62 or as late as age 70.
Even though you can start taking Social Security Income as early as age 62, there are penalties to claiming your benefits earlier than Full Retirement Age. If you take Social Security at age 62, there will be a 30% reduction in your income amount.
For the sake of example, I’m going to use pseudonyms for real-life clients I worked with to illustrate how this works. Let’s say “Sarah’s” full Social Security benefit is $2,000. Had she started taking Social Security Income at age 62, she would have received about $1,400. That a difference of $600 a month. You might think that’s not a big deal, but it is. That’s $7,200 a year over her lifetime. Over 10 years that’s $72,000, and over 20 years that’s $144,00 of income she would have missed. That’s a lot of money!
So although the government lets you begin taking your Social Security income at age 62, they’ll reduce your benefits by 30%. If you take your benefits at age 63, you’ll receive a 25% reduction. At age 64, there’s a 20% reduction. At age 65 (for those of us born after 1960), there’s a 13.3% reduction, and at age 66 there’s a 6.7% reduction.
The point is that you can start taking your Social Security income early. You can. Yet, if you do so, you are going to have a reduction in your benefit amount. Additionally, you may face another type of “penalty.” Not only will you have a reduction in your benefit amount if you take Social Security early, you will have to pay taxes on your benefits if you are still working. I’ve seen many business owners do this out of ignorance. They start their income early while they are still working, but their paid benefits are open to taxation.
Here’s how that works. If you are filing a joint tax return and you and your spouse have combined incomes below $32,000, then you do not owe taxes on your Social Security benefit. If your combined income is between $32,000 and $44,000, then up to 50% of your benefits are taxable. However, if you make more than $44,000 combined, then up to 85% of your benefits may be taxable. Now I don’t know about you, but as a business owner, I think $44,000 is a relatively low number. I certainly want to go into retirement with more income than that.
Thus, if you are collecting Social Security benefits at age 62, you’re receiving a 30% reduction in your benefits. Then, if you’re still working and making greater than $44,000, that reduced benefit is taxable. Up to 85% of the benefit is taxable, so it’s like a double-whammy. That’s like a double knock-out punch right there.*
What’s the key, then? What does this information teach us?
Now, you may get smart and say, “Well, Justin, I’m actually going to go ahead and start taking my benefits early, but I’ll delay my spouse’s income. Thus, we can make up the reduction.” Okay, but doing so actually hurts your spouse’s income, too.
Go back to my client “Sarah.” Let’s say that Sarah and “Tim” are married. Sarah was the bread-winner for her family, and Tim raised the children. Sarah maxed out her Social Security income during her working years, so her non-working spouse is eligible for 50% of her benefit. Thus, in Sarah’s case, Sarah was eligible for $2,000 a month at full retirement age. Tim would have received $1,000 a month. But here’s the problem; Sarah took her benefit early, so she had a 30% reduction in benefit. Her spouse’s reduction was about 35%, so where he was going to get $1,000, now he’s only getting about $675 a month. That’s crazy!
Can you name any other asset in which you could potentially invest that would give you a guaranteed 8% increase in your benefit AND be backed by the U.S. government?Click to tweet
If you can take your Social Security benefits as early as age 62, then what’s the latest you can begin drawing Social Security income? Technically, you can delay it as long as you want. However, your benefits stop growing at age 70, so you’re throwing money away if you delay taking your benefits after age 70.
Yet, if you wait until age 70 to take your benefits, you get some pretty cool “perks.” If your full retirement age is 67 and you delay taking your benefits until age 70, you get a guaranteed 8% yearly increase in your benefit amount. That’s even guaranteed by the U.S. government which has the full taxing weight of Congress behind it.
Here’s how that works. If you reach Full Retirement Age at 67 but you delay taking your Social Security income until age 70, you’ll receive a 24% greater monthly benefit. That’s just by delaying your benefits for 36 months. You may not think it’s a big deal, but can you name any other asset in which you could potentially invest that would give you a guaranteed 8% increase in your benefit AND be backed by the U.S. government? I can’t. You’re certainly not going to make a guaranteed 8% in the stock market. Sure, you may make greater than that some years, but it’s not backed by the U.S. government. You could probably increase your business’s revenue by 8% each year, but you can’t do it risk-free.
In “Sarah’s” case, if she waited until age 70 to take her Social Security benefits, she would get roughly $2979 per month. That’s $979 more than the $2000 she would receive each month if she took her benefits at age 67 and over $1500 more than the $1400 she would receive each month if she took her benefits at age 62. Full Retirement Age would be Sarah’s minimum target, then, but she would earn much more if she could wait until age 70 to take her Social Security benefits.
Now, some of you analytics may be saying, “Justin, what happens if I take my Social Security benefits early and invest them?” or “What happens if I wait to take my benefits until I’m 67, but I don’t live very long?” Essentially, what you’re asking is, “How long do I have to live in order to make delaying my benefits to age 70 make sense?” You’re looking for the break-even point. Obviously, you don’t know how long you’ll live. If you had a crystal ball and knew exactly what the future held, you could pinpoint the exact date to start taking your Social Security benefits. But since no one knows what the future holds, the best you can do is run calculations to determine your break-even point.
Let’s go back to Sarah and Tim and do the math. If Sarah had started taking her income at age 62, she would have received $17,400 per year for the rest of her life, however long she lived. If she waited to age 66, she would have gotten $24,000 a year, and if she had waited to age 70 to take Social Security, she would have received $35,748 per year.
Let’s assume Sarah will live past age 90 as her parents did. Had she started taking her benefits at age 62, she would have received a total of $522,000 in income over the years. Had she waited to Full Retirement Age, she would have received $624,000 over the rest of her life and had she waited to age 70, she would have received $786,456 over the years. That means that she would have received $264,456 MORE in cash flow to her family unit just by delaying her Social Security benefits!
Yet, what happens if Sarah doesn’t live to age 90? What if she only lives to be 80? Go back to the graph. If she had taken her income benefits at age 62, then she would have received $330,600 in her lifetime. At Full Retirement Age, she would have received roughly $30,000 more. But had she waited to age 70, she would have received roughly $63,000 more in income to her cash flow, or $393,228.
So friends, the crossover or break-even point comes into play when you’re trying to decide when to begin your Social Security income benefits. Based on the calculations, I highly recommend that you start collecting your benefits as late as possible. However, I recognize that there may be reasons why you need to take your benefits early.
Yet, if you are in good health, if you’re still working in your business, and if you have enough financial assets built up, you probably want to delay taking your Social Security income benefits as long as possible. Let your business provide your income until you reach Full Retirement Age at the very least.
NEXT STEPS: go to the beginning of this series – Personal Finance for the Business Owner covering all aspects of wealth growth and tax minification as it applies to you, the business owner.
*Assumptions used in the graphics