The Danger of Trusting Social Security’s Online Advice

By Larry Kotlikoff

Don’t assume that Social Security’s website is giving you all of the information you need. Photo courtesy of Flickr user Kimberly B.

Larry Kotlikoff’s Social Security original 34 “secrets”, his additional secrets, his Social Security “mistakes” and his Social Security gotchas have prompted so many of you to write in that we now feature “Ask Larry” every Monday. We are determined to continue it until the queries stop or we run through the particular problems of all 78 million Baby Boomers, whichever comes first. Kotlikoff’s state-of-the-art retirement software is available here, for free, in its “basic” version

Larry Kotlikoff: Here’s a question I’m posing myself this week: Can we trust Social Security’s online advice?

The answer is no. Here’s an example, which purports to explain spousal benefits:

A spouse can choose to retire as early as age 62, but doing so may result in a benefit as little as 32.5 percent of the worker’s primary insurance amount. A spousal benefit is reduced 25/36 of one percent for each month before normal retirement age, up to 36 months. If the number of months exceeds 36, then the benefit is further reduced 5/12 of one percent per month. This reduction factor is applied to the base spousal benefit, which is 50 percent of the worker’s primary insurance amount. For example, if the worker’s primary insurance amount is $1,600 and the worker’s spouse chooses to begin receiving benefits 36 months before his or her normal retirement age, we first take 50 percent of $1,600 to get an $800 base spousal benefit. Then we compute the reduction factor, which is 36 times 25/36 of one percent, or 25 percent. Applying a 25 percent reduction to the $800 amount gives a spousal benefit of $600. Thus, in this case, the final spousal benefit is 37.5 percent of the primary insurance amount.

The statement is correct for a spouse with no earnings history. But for a spouse with an earnings history, this sentence is simply wrong: “This reduction factor is applied to the base spousal benefit, which is 50 percent of the worker’s primary insurance amount.”

The reduction factor is applied not to the base spousal benefit, but to the excess spousal benefit, which is the base spousal benefit minus the spouse’s own primary insurance amount (full retirement benefit). If this difference is zero, the excess spousal benefit will be set to zero.

For many, if not most spouses, their excess spousal benefit will, indeed, be zero. So the most important message for Social Security to convey about taking spousal benefits early is that doing so may wipe them out. They won’t be wiped out because of a reduction factor for having taken them early, but rather because the reduction factor is applied to the excess spousal benefit, not to the full or base spousal benefit.

And the reason that the excess spousal benefit, not the full spousal benefit formula is used, is because of Social Security’s “gotcha” that says if you have ever filed for your own retirement benefit, your spousal benefit is calculated as the excess spousal benefit, not the full spousal benefit. You have to file for your own retirement benefit if you take your spousal benefit early because of Social Security’s deeming provision. In other words, when you collect your spousal benefit early, Social Security deems you to be filing for your own retirement benefit at the same time.

Indeed, the only way you can get a full spousal benefit is to wait until full retirement age and apply just for the spousal benefit at that time. This should be the first statement appearing on Social Security’s site describing spousal benefits.

So, why doesn’t Social Security provide this information? Either they think that no spouses ever worked, which is simply nuts, or they think explaining everything I just explained is too hard, to which I say, “Too bad — explain it for God’s sakes!” They trap people into thinking they are going to get a spousal benefit, but then don’t give it to them.

I don’t believe they are intentionally trying to trap people. But I believe their “advice” traps people into making the wrong decisions. Furthermore, the checks you get in the mail don’t clarify what benefits you are and aren’t receiving. So you may think you are getting a spousal benefit, when actually, it’s only a reduced retirement benefit since your excess spousal benefit is zero.

John B. — Tucson, Ariz.: I’ve worked in social services, so I know you’re likely in the top 1 percent. Have you ever been to a job service and stayed for a day or two to see who’s not getting work? How about a food bank to see who needs to eat? A homeless shelter? Your across-the board advice to not collect Social Security at age 62 is not realistic unless you’re in the income bracket your viewers seem to be in. People need Social Security. It’s not for bills and a vacation, but for bills and food to live — and not well in many cases. We hear that the market is up and everything is good. Get real.

Larry Kotlikoff: I hear you, John. I have been to homeless shelters and am sickened to my core by the poverty and inequality our country tolerates. I also realize that many — probably most — people don’t have the luxury of waiting to collect Social Security benefits or using the best collection strategies, which sometimes entail first taking one benefit that’s lower, then switching to another, higher benefit later.

This is another hidden way that our government policies often favor the rich over the poor. If people can’t keep working, and most, unfortunately, can’t and have no other means of support, they have to take what they can get from Social Security as soon as they can get it, making my “brilliant” advice irrelevant and insensitive.

Sherrie N. — St. Charles, Ill. In 2009, I was forced into early retirement after 22 years working. I am now disabled from Lupus and other health issues. Will my pension benefits decrease now that I receive disability benefits? Due to high medical costs, I can’t afford to lose either one. In fact, I continue to enroll in my annual retiree health plan and use it in conjunction with Medicare because the premium is lower than enrolling in a new supplemental/Medicare plan at my age and because those plans don’t cover prescriptions. Is this going to affect my benefits at age 62 or 65?

Larry Kotlikoff: Unless your disability pension from your job specifies reduced benefits when you start receiving Social Security disability benefits, I can’t see why your disability pension from your job would be affected by receipt of a Social Security disability benefit. Social Security disability benefits, if they push your adjusted gross income above a certain threshold, can be subject to federal income taxation. So there may be some interaction between the two pensions through the federal income tax, but I doubt that would apply in your case.

Stephen — Pflugerville, Texas: I am 63, still working, and trying to maximize my 401K. My company has 10 funds to choose from, three of which are managed by the company with no fee: equities (all stock), balanced (60-40 stocks/bonds) and fixed (some type of ultra safe treasuries/municipal mix that goes down when the market goes up). The other funds are one income funds (all bonds) and target date funds managed by Vanguard for a pretty low fee.

I’m invested 100 percent in equities now, trying to ride the wave up, but if the 30,000 point correction comes, I just don’t know where the safe harbor is anymore. I’d like to keep retirement on the horizon and just can’t afford to take a 35 percent hit the way I did in 2009 when I was just in the balanced fund. I’m trying to work until I’m 70 to stay ahead of inflation if it comes, but it’s scary for us Main Streeters with even a toe in the water with the sharks. So, fixed fund, income fund, or give up and just leave it to the 2020 target date people? I like the annuity idea, but I’m thinking the prices will be better once interest rates rise. I’ve even heard that people with annuities tend to live longer.

Larry Kotlikoff: My advice on portfolio allocation is to practice what my software company calls “upside investing.” Treat investing in the stock market or other risky securities like going to the casino. When most of us go to the casino, we take a fixed amount of cash and leave our wallets behind, or we go with a maximum amount of money in mind that we are prepared to lose. Setting these limits establishes a floor to our living standard. If we lose all the money we gamble with, we’ll still have the money in our wallet to spend.

The more money you put in, say, the stock market, the less you have to establish a safe floor to your living standard, but the larger will be the upside to your living standard once you convert any returns from your stocks into safe assets and, thereby, establish a higher living standard floor. So more money in the stock market means a lower floor, but a higher upside to your living standard. And putting less money into the stock market means a higher floor, but a lower future upside.

Now for the tricky question. Which asset is safest? I think fixed income funds are highly risky if they are invested in bonds of even five or more years. The Fed has been printing money like crazy for five years. It’s quadrupled the basic amount of money in the economy, called the “monetary base.” The money in circulation, called “M1,” has risen by 86 percent. But prices have risen only 15 percent — so far! I expect a lot of inflation going forward. Indeed, I can make a strong case that we’ll have hyperinflation because the amount of money creation is so unprecedented.

The only safe asset yielding a decent return is long-term inflation-indexed bonds, when held to maturity. The implied real yield on 30-year Treasury Inflation-Protected Securities (TIPS) is currently 1.4 percent. Unfortunately, the nominal, not the real return, is subject to federal income taxation, so TIPS, like other bonds, can get taxed heavily during periods of high inflation.

Another option is to buy fully inflation-protected annuities from a top-rated insurance company. But don’t put all your eggs into one company’s products. Insurance companies may not last as long as you do.

The best advice I have is to work as long as possible, maximize your Social Security benefits using the strategies I’ve been discussing in my weekly Q&As, and own your house and pay off its mortgage. (The housing services are, themselves, a real annuity because they continue until you die.) Read more about annuities on the Business Desk from Lew Mandell: “An 8.3 Percent Return on Your Money, Guaranteed for Life?”

Deborah — Royal Oaks, Calif.: I’m retiring in eight months from county government employment at age 63. I’ve put 30 years into a Public Employees Retirement System (PERS), with payment into Social Security. My husband is 71 and a retired teacher. The State Teachers Retirement System (STRS) did not pay into his Social Security. He does get a minimal amount in Social Security (maybe $150) from other miscellaneous jobs he had before teaching. Is he eligible to receive a portion of my Social Security instead of his, either while I’m alive or if I predecease him? I won’t be applying for my benefits until I turn 66.

Larry Kotlikoff: First, you may not want to start collecting your own retirement benefit until you are 70 because it will start at a 32 percent higher value, after inflation, than if you take it at 66.

Once you reach 66, however, you can file for your retirement benefit and suspend its collection. This will permit your husband to potentially collect a spousal benefit based on your earnings record. The reason I say “potentially” is that his spousal benefit will get zapped two ways.

First, because he has filed for his own retirement benefit, his spousal benefit will be calculated as his excess spousal benefit, equal to the difference between half of your full retirement benefit and 100 percent of his full retirement benefit. This excess spousal benefit will, no doubt, be positive given that he contributed very little to Social Security.

The second form of zapping comes from the Government Pension Offset provision, which will reduce his excess spousal benefit by two-thirds of his pension from non Social Security-covered employment. If two-thirds of his STRS pension exceeds his excess spousal benefit, he’ll get no spousal benefit. If this is the case, but his STRS pension is not inflation-indexed, two-thirds of his fixed STRS pension may eventually be less than his excess spousal benefit, whose value will rise with inflation thanks to Social Security’s annual cost-of-living adjustments.

If you pass away before your husband, he’ll receive an excess survivor benefit equal to the difference between your retirement benefit and his, again, reduced by two-thirds of his STRS pension. Since the excess survivor benefit is bigger than the excess spousal benefit, his ultimate survivor benefit amount may end up being positive, even if his ultimate spousal benefit is not.

There is one other strategy to consider, if you wait until 70 to collect your own retirement benefit: don’t file and suspend at full retirement age. By not filing and suspending before 70, your husband won’t be able to collect a spousal benefit before you are 70. However, at full retirement age, you can apply just for a full spousal benefit based on your husband’s work record. It’s worth running your situation through a software program that can determine which option will maximize your lifetime benefits.

Arthur — St. Croix, U.S. Virgin Islands: I plan to take benefits next year when I’m 70. My spouse will be 62 at that time. I understand she will receive reduced benefits (32.5 percent) if she does that. Will her benefit increase to 50 percent if I die before her?

Larry Kotlikoff: If your wife takes her spousal benefit when she is 62, she will be forced to take her retirement benefit at the same time. And if she takes her retirement benefit at 62, she will be forced to take her spousal benefit at 62. This is Social Security’s rather nasty deeming provision, which I described above in today’s first question.

Her total check will consist of her own reduced retirement benefit, plus her reduced excess spousal benefit. Her age-62 reduced retirement benefit will be 75 percent of her full retirement benefit and 57 percent of her age-70 retirement benefit, were she, like you, to wait until 70 to collect her retirement benefit.

Given her age, her reduced excess spousal benefit should be 70 percent (1 minus 30 percent, not 1 minus 32.5 percent) of her excess spousal benefit. Her excess spousal benefit is half of your full retirement benefit, less 100 percent of her own full retirement benefit. If this difference is negative, her excess spousal benefit will be set to zero.

So, you may be making a big mistake with respect to your wife’s benefits by following your intended strategy depending on her own earnings history and potential lifespan. If she has a decent earnings record, it may be best to have her wait until full retirement age and then have her take just her full spousal benefit, which will equal half of your full retirement benefit, and then have her wait until 70 to collect her own retirement benefit.

Even if she has no earnings record or a very small one, waiting until full retirement age to collect a non-reduced spousal benefit (for what could be 35 years of retirement) may be better than collecting what will be a permanently-reduced spousal benefit at 62.

One other thing regarding survivor benefits. When you pass away, your wife will receive 100 percent (not 50 percent) of the retirement benefit you were collecting unless you die before she reaches 66 (her full retirement age) and she opts to take her survivor benefit early, in which case it will be reduced.

This entry is cross-posted on the Rundown — NewsHour’s blog of news and insight.