Social Security provides retirement income you can’t outlive.
And, in addition to your own benefits, your spouse may be eligible to receive benefits based on your earnings record in the form of spousal benefits and survivor’s benefits. It’s easy to see why Social Security is an important source of retirement income.
However, according to the Social Security Administration, only about 40 percent of an average worker’s pre-retirement income is replaced by Social Security. When trying to figure out how you’ll meet your retirement income needs, you’ll probably have to coordinate your Social Security benefits with other retirement income sources such as pensions, qualified retirement accounts and other personal savings.
Factors to consider
How you incorporate Social Security benefits into your total retirement income plan may depend on a number of factors, including whether you’re married, your health and life expectancy, whether you (or your spouse) will work during retirement, the amount of your Social Security benefit (and that of your spouse, if applicable), other sources of retirement income (like a pension), how much retirement savings you have, and, of course, your retirement income needs of you and your spouse, including the income needs of your spouse after your death.
A factor to consider is that Social Security has a “built-in” protection against longevity risk. Benefits increase each year you delay starting benefits through age 69. Benefits do not increase past age 70. The later you start receiving benefits, the greater the benefit amount. In addition, Social Security benefits are inflation-protected, and may increase with annual cost-of-living adjustments based on increases in the Consumer Price Index.
How much you may pay in income tax may also factor into your retirement income plan. For example, distributions from tax-qualified accounts are generally taxed as ordinary income. Up to 85 percent of your Social Security benefits may also be taxed, depending on your modified adjusted gross income and tax filing status. Tax issues are complex, so you should talk to a tax adviser to understand your options and the tax consequences.
If you’re lucky enough to have a traditional employer pension available, that’s another reliable source of income. You’ll want to be sure that you effectively coordinate your Social Security benefits with pension income. Your pension may increase in value based on your age and years of employment, but it may not include cost-of-living adjustments. As mentioned earlier, Social Security not only increases the longer you delay taking benefits, but it may increase with COLAs.
If your pension benefit increases past the age at which you retire, you might consider waiting to take your pension in order to maximize your pension benefit amount. Depending on your income needs, you could start Social Security benefits earlier to provide income. Or, if you’ve already reached your maximum pension benefit, you could start your pension first, and defer Social Security in order to receive an increased monthly benefit later. Your decision depends on your individual situation, including your pension benefit amount and whether it increases in value after you retire, and the pension options that are available to you. You can get an explanation of your pension options prior to retirement from your pension plan, including the relative values of any optional forms of benefit available to you.
Prior to retirement, when it came to personal savings, your focus was probably on accumulation – building as large a nest egg as possible. As you transition into retirement, that focus changes. Rather than concentrating on accumulation, you’re going to need to look at your personal savings in terms of distribution and income potential. Your savings potentially can provide a source of income to help you bridge any gap between the time you begin retirement and the time you wait to begin taking Social Security benefits.
One option you might consider, depending on the amount of retirement savings you have and your income needs, is taking some of your savings and purchasing an immediate annuity, which will provide a guaranteed (based on the claims-paying ability of the annuity issuer) income stream. In this way, your remaining savings may have a chance to increase in value, while delaying Social Security benefits increases your annual benefit as well.
Incorporating Social Security into your retirement income plan involves several other important factors. Talk to your financial professional for help in developing the best plan for you.
Bruce Wingrove is a financial adviser for Ameriprise Financial Services, Inc. His office is in Salt Lake City, however, he regularly works in Tooele and Grantsville meeting clients at any of the three H&R Block tax offices.