A widow's Social Security dilemma

Earnings test complicates choice between retirement and survivor benefits

By Mary Beth Franklin

Jun 16, 2016 @ 1:00 pm EST

When it comes to collecting Social Security benefits, widows and widowers have more options than other beneficiaries. If a surviving spouse is entitled to both a retirement benefit on his or her own work record and a survivor benefit based on a deceased spouse's earnings, the survivor can collect one type of benefit first and switch to the other later if it would result in a bigger payment.

Recently, a financial adviser asked my opinion about one of her clients who was widowed last year. It serves as a great case study on how the earnings cap can complicate a Social Security claiming decision.

Anyone who collects any type of Social Security benefit before full retirement age is subject to earnings restrictions that can temporarily reduce or eliminate benefits.

Beneficiaries who are under full retirement age for the whole year lose $1 in benefits for every $2 earned over $15,720 in 2016. That means anyone earning $47,160 ($15,720 x 3) a year or more would forfeit all benefits. In the year you reach full retirement age, a much higher earnings limit applies. You would lose $1 in benefits for every $3 earned over $41,880 in the months preceding your birthday. Once you turn 66, the earnings cap disappears and benefits lost to the earnings cap would be restored in the form of higher monthly benefits.

In this case study, the widow is 63 years old and earns $29,000 per year. Her husband was collecting $1,775 per month in Social Security benefits when he died last November. She needs to either tap her investments or collect Social Security benefits to fill an income gap of about $1,000 per month, the adviser said. The client is also the beneficiary of a $200,000 life insurance policy.

At 63, her own retirement benefit is worth just $660 per month, compared to $837 per month if she waited until her full retirement age of 66 or a maximum benefit of $1,100 per month if she delayed until age 70. Her own retirement benefit will never exceed her survivor benefit, which is worth about $1,562 per month now versus $1,775 per month if she waits until 66 to claim it.

“We were thinking maybe she takes her benefit now and his when she is 70,” the adviser wrote.

Unfortunately, that won't work. Survivor benefits are worth the maximum amount if collected at full retirement age. They do not grow larger by waiting until age 70 to claim them. Only a worker's retirement benefit qualifies for delayed retirement credits that increase benefits by 8% for every year benefits are postponed beyond full retirement age up to age 70, for a potential boost of 32%.

Generally it would make sense for the widow to collect her smaller retirement benefit now and switch to the larger survivor benefit at full retirement age, when the survivor benefit is worth the maximum amount and the earnings cap no longer applies.

But her annual earnings of $29,000 complicate matters. They are nearly double the $15,720 annual earnings limit for 2016. Consequently, she would forfeit about $6,440 in Social Security benefits if she claimed this year. ($29,000 - 15,720 = $13,280/2 = $6,440). That would wipe out the majority of her retirement benefits of $7,920 per year ($660 x 12).

If, instead, she decided to claim her survivor benefit, SSA would withhold five months of benefits ($1,562 x 5 = $7,810) to satisfy the earnings cap reduction of $6,440. After that, she would receive monthly benefits for the remainder of the year, totaling nearly $11,000 a year, and the excess $1,370 that was withheld due to earnings restrictions ($7,810 -$6,440) would be repaid the following year.

Because of her earnings, neither claiming option is very attractive. I think it would make sense to use the tax-free life insurance proceeds to fill the client's income gap for a few years. In the interim, she could claim a small portion of her reduced retirement benefits each year after the earnings cap was satisfied and switch to full survivor benefits at 66 to collect the maximum benefit for the rest of her life. Or, she could skip her retirement benefits altogether and collect reduced survivor benefits now knowing her benefits would increase slightly at age 66 after amounts forfeited to the earnings cap reductions are restored.

Separately, another adviser wrote to me about his client, a 61-year-old widower who earns $48,000 a year — enough to wipe out all Social Security benefits before full retirement age. Reduced survivor benefits are available as early as age 60. In his case, he may want to collect full survivor benefits in the year he turns 66 and switch to his own larger retirement benefit at 70 that would include four years of delayed retirement credits.

Deciding when to claim survivor or retirement benefits is much easier when the beneficiary is not working or is full retirement age or older when the earnings cap no longer applies. The longer the beneficiary is likely to live, the better it is to hold out for a bigger benefit.

(Questions about new Social Security rules? Find the answers in my new ebook.)

Mary Beth Franklin is a certified financial planner.

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