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Social Security Confusion: Our Expert Dispels Some More

Social Security Wall Art
Creative Commons photo courtesy Flickr user Fabricator of Useless Articles.

The Social Security tsunami continues with more queries for retirement authority Larry Kotlikoff. Larry’s Making Sen$e post earlier this week, 34 Social Security Secrets You Need to Know Now, has drawn a flood of views thus far, suggesting an unusual level of interest in the intricacies of Social Security — or simple despair.

Larry answered a host of questions from Making Sen$e readers Wednesday, and he’s tackled more below. Don’t yet see your issue? Come back Friday, when we’ll have even more from Kotlikoff.

Questions may be edited for clarity and style.

Making Sense

curiosty123: I’m still a little confused. [In our household, the] higher-earning spouse started collecting at 66. The lower-earning spouse is 62, but has not sought Social Security. Neither wants to wait until 70. Should the lower-earning spouse apply now for benefits?

Larry Kotlikoff: Because the older and higher-earning spouse, person A, has already started collecting, the lower-earning spouse, person B, who is younger than full retirement age will be forced to take her retirement benefit early if she takes her spousal benefit early and vice versa.

If B waits until full retirement, she can collect half of A’s full retirement benefit and then, at 70, start collecting the highest possible retirement benefit, which may exceed half of A’s full retirement benefit. In this scenario, B will start collecting her spousal benefit at 66 and her retirement benefit at 70. Her own retirement benefit at age 70 will be 32 percent higher than at full retirement age (66). So if she waits to start collecting it, she’ll get more than half of A’s full retirement benefit. In other words, B’s total check starting at age 70 will go up and stay higher forever.

This is probably the best thing for B to do if her earnings, even though lower than A’s, have been non-trivial. Or it may be better for cash flow reasons or if B is sure to die at a relatively young age for B to start collecting benefits before full retirement age. In this case, if she qualifies for a spousal benefit as well as a retirement benefit, she’ll get both her retirement benefit and her excess spousal benefit, but both will be reduced. (Again, assuming B’s full retirement benefit is less than half of A’s.)

Our software at maximizemysocialsecurity.com can figure out what’s best for this couple but remember, it costs money.

james walser: I believe that the “file and suspend” provision is only available to those who have reached “full retirement age.” Right, Larry? Suppose at 62 you file for benefits for yourself as well as school-age dependents, but due to your income, your benefits are reduced to zero. Do the dependents receive benefits anyway?

Larry Kotlikoff: You can only suspend your retirement benefit after reaching full retirement age. If you file at 62 for retirement benefits and start earning money, both your benefit and your spousal and child benefits will be proportionately cut due to the earnings test. I.e., the earnings test is applied to total family benefit. Social Security’s Adjustment of the Reduction Factor, which would come into play at your full retirement age, would compensate you fully for losing your retirement benefits due to the earnings test. But your spouse’s loss of spousal benefits would not necessarily be recouped when she reaches full retirement age because if she receives her spousal benefits when she has a dependent child, her spousal benefit, actually called her mother’s benefit, is not reduced. So since there is no reduction applied in calculating her spousal benefit, there is no adjustment of the reduction factor. For your dependent child, the child benefits lost due to your earnings are not recouped. They are just lost. So, the answer is that if you earn enough, your child and spouse will not receive benefits anyway and they won’t be recouped.

Alangrant9: I don’t understand item No. 33 regarding taxation. Could you please define the taxation issue in all regards?

Larry Kotlikoff: Back in 1983, Congress passed a bill reforming Social Security in which they planted a time-bomb with respect to taxing Social Security benefits under the income tax. This was the brainchild of David Stockman, then Office of Management and Budget director under President Reagan. I will be writing a column in Forbes in the next few days, entitled “Thomas Jefferson Is Rolling in His Grave — The Taxation of Social Security Benefits.” I’m writing this in response to your request to “define the taxation issue in all regards.”

When I read your request, I cringed. I’ve known in my guts that this part of the federal tax code, like the “simple” Social Security benefit formula I discussed in this article, is diabolically complex. I thought I had a pretty clear idea how it worked, but I’ve been scared for years to look at it carefully. In our ESPlanner software, we just follow the IRS worksheet line by line, but coding up this craven tax system and really understanding it are two different things. I was scared about trying to really understand it because I knew I would lose a night’s sleep trying to figure it out. Sure enough, I sat down at 10 p.m. to try and respond to your innocent query and turned in abject fear to the IRS worksheet that determines how much of your benefits are taxable.

Three hours later I still hadn’t sorted it out. I hit the hay, but I spent all night thinking in a quasi slumber, “They cannot, they simply cannot be calculating the taxable portion of the benefits this way.” At 6 a.m. I woke up with the damn worksheet right in my brain and realized the only way to make sense of it was to write it down as another “simple” mathematical formula. An hour later I had it straight. The formula involves three minimum functions and two maximum functions and the main part is of the form min (.5 x min(blah, .5 x min(blahblah), .85 x max (ugh), .85 (ughugh). So please look for my column to get your answer on this. Making Sen$e may link to it or post it here.

Donald Campbell: I have been married twice and each of my spouses both past and present have been married twice. I was married to my first spouse, now my ex-spouse for three years and I have been married to my present spouse for eight years. What happens if I die tomorrow and both spouses file to collect their “entitlement” to my Social Security Benefits; since both ex-spouse and present spouse are the same age what would happen for each of them at say age 62?

Larry Kotlikoff: Ah, a typical American extended family. Your first spouse is out of luck because you weren’t married to her for 10 or more years, so she can’t collect a spousal benefit based on your earnings record, and since you aren’t currently married to her, she can’t collect a survivor benefit due to your dropping dead tomorrow. (So don’t do that.)

Your current spouse can collect a spousal benefit based on your earnings record if you hang onto both your marriage and life for two more years. If you croak tomorrow, your current spouse will be eligible to collect a survivor benefit based on your earnings record. So will your kids if they are under age 18 (19 if still attending elementary school or high school).

This entry is cross-posted on the Making Sen$e page, where correspondent Paul Solman answers your economic and business questions

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