Saving Grace, The Early Filing Bear Trap
As Capital Investment Advisor’s resident Social Security specialist, I spend a fair amount of time helping people with their benefits filing strategy. Many times, in that process, I discover that would-be retirees are not aware of how filing early could have a negative impact on their monthly Social Security benefit check. In this article, I will review and educate you on this less-than-well-known strategy, as it might help you avoid an unintended misstep in your retirement planning.
It has been almost eight years since the passing of the Bipartisan Budget Act (November 2015). This piece of legislation, among other things, closed the door on the Social Security “file and suspend” strategy but opened a temporary window for the “restricted application” strategy. This specific strategy permits any applicant born before January 2, 1954, to collect their spousal Social Security benefit while waiting until age 70 to maximize their lifetime Social Security benefit, provided certain conditions are met. But the “restricted application” option sunsets on January 2, 2024, because on this date, any applicant born before January 2, 1954, will be age 70 or older. And waiting beyond age 70 to file does not increase your benefits. Remember, you only earn delayed retirement credits between your full retirement age (FRA) and age 70.
And on that note, some may say that little to no thought is required when it comes to your filing strategy. Meaning if you want to increase your benefits, just wait longer to file. And while that might be true, you might be surprised to learn that filing early (before your FRA) can result in unwanted outcomes, which I have dubbed the early filing bear trap.
Most people don’t realize that there are three (3) separate reduction formulas in play if you file before your FRA that apply to your holy trinity of Social Security benefits: Lifetime, Spousal, and Survivor.
Here is how they work.
1. Lifetime Reduction Formula
The Lifetime Reduction Formula (LRF) reduces the benefit you are eligible to receive on your earnings record by 5/9 of 1% per month for the first 36 months and then 5/12 of 1% for each additional month. Sounds complicated, right?
Let’s simplify this with an example.
If your FRA is 67 and you file between ages 64 and 67, your benefit is reduced by 6.7% per year for a total reduction of 20%. Then tack on an additional 5% reduction for each additional year. So, if you file at 62 (and your FRA is 67), you incur the maximum reduction of 30%.
2. Spousal Reduction Formula
The Spousal Reduction Formula (SPRF) reduces the benefit you are eligible to receive on your spouse’s earnings record by 25/36 of 1% for the first 36 months and then the same 5/12 of 1% for each additional month. Wait, what?
Said another way and sticking with the logic above, that is an 8.3% per year reduction for a total reduction of 25% in the first 3 years with a maximum reduction of 35%.
3. Survivor Reduction Formula
Perhaps the most egregious of the three, in my opinion, is the Survivor Reduction Formula (SURF), which reduces the benefit you are eligible to receive as a widow or widower. As if losing your spouse isn’t enough. The maximum reduction is 28.5%. Keep in mind the earliest that a survivor benefit can be claimed is age 60 (unless the applicant is disabled or caring for a child under age 16). The reduction is calculated by dividing 28.5% by the total number of possible months of early retirement, which in this example is 84 months (from age 60 to 67). If you divide 28.5% by 84 months, that is 0.339% per month or 4.1% per year.
Let’s review a hypothetical example and how these formulas might apply.
Meet Grace and Larry. Grace is 62 and is eligible for the following monthly lifetime benefits on her earnings record:
- 62: $800
- 67: $1,145 (FRA)
- 70: $1,420
Larry is 67 and has not filed yet. His monthly lifetime benefits are:
- 67: $2,800 (FRA)
- 70: $3,472
Grace files at 62 and Larry files at 67.
- Larry gets $2,800 per month.
Is Grace eligible for a spousal benefit greater than her lifetime benefit of $800 per month?
Yes. However, she is not eligible for 100% of her spousal benefit (which would be 50% of Larry’s FRA benefit = $1,400 per month).
Why? Because Grace filed five years before her full retirement age, and the maximum SPRF applies. So, instead of receiving $1,400 per month, her spousal benefit is reduced by 35% to $910 per month.
If you think that’s bad, let’s take it one step further. Larry pre-deceases Grace. Grace heard that she gets to step up to Larry’s benefit after he passes away, which is partially correct. To say she is somewhat deflated is an understatement when the Social Security representative informs her that because she is filing for her survivor’s benefit at 62, her survivor benefit is reduced (SURF reduction) by 20.4%. So, instead of stepping up from $910 per month to $2,800 per month, she steps up to $2,230. Not what she was expecting.
What if Larry waits to file at 70 instead of 67?
From a SPRF standpoint, there is no change. A common misconception is that if Larry waits until 70, Grace is eligible for up to 50% of $3,472 (instead of up to 50% of $2,800). And that is not the case. The spousal benefit is capped at 50% of your partner’s FRA benefit (not the maximum benefit at age 70). So, she still gets $910 as a spousal benefit. But keep in mind, she doesn’t get the $910 until Larry files at age 70. Until then, she gets her lifetime benefit of $800 per month.
If Larry passes, Grace steps up to $3,189 per month (instead of $3,472 per month) if she files for her survivor benefits at 65. Why? Because she filed two years before her full retirement age, which reduces her survivor benefit by 8.1%.
How do we save Grace?
A way for Grace to avoid the early filing bear trap is to wait until she reaches her FRA of 67 to file for benefits. Said another way, once you hit full retirement age, the LRF, SPRF, and SURF no longer apply.
One final heads-up that you might not be aware of: there is a Social Security relic that the Bipartisan Budget Act did not repeal related to survivor benefits. And it is simply this:
- “If you are also eligible for retirement benefits but haven’t applied yet, you have an additional option. You can apply for retirement or survivor benefits now and switch to the other (higher) benefit later.” (1)
So, let’s flip the tables on Grace and Larry for the final example.
Larry is 67 but hasn’t filed, and Grace passes away at 62. Instead of filing for his benefit at 67 ($2,800 per month), Larry has the option to take Grace’s FRA benefit of $1,145 per month as a survivor benefit. Then, at age 70, he can switch to his maximum benefit of $3,472 per month. And for what it’s worth, this still plays if Larry and Grace were divorced, provided that:
- Larry and Grace were married for at least ten years
- Larry did not remarry before age 60
If you are not confused, congratulations. Filing for Social Security benefits is not a decision to take lightly. And by no means is there a one-size-fits-all filing strategy. Like anything else in life, it is a decision you need to make eyes-wide-open. When you file impacts not only your own benefits but also your spousal and survivor benefits. While discussing hypothetical filing strategies centered around survivor benefits with your trusted financial advisor may not sound like a pleasant conversation, being mindful of the consequences of your filing strategy is much more palatable. Try to think through the benefits and not be blindsided by a lower-than-expected survivor’s benefit, especially after losing a loved one.
Source: (1) SSA.gov
Disclosure: This information is provided to you as a resource for informational purposes only and is not to be viewed as investment advice or recommendations. This information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. This information is not intended to, and should not, form a primary basis for any investment decision that you may make. Always consult your own legal, tax, or investment advisor before making any investment/tax/estate/financial planning considerations or decisions. The views and opinions expressed are for educational purposes only as of the date of production/writing and may change without notice at any time based on numerous factors, such as market or other conditions.