Social Security Planning: There’s Much More to it Than You Think

With 401(k) accounts taking big hits in 2020 and 2022, Social Security will play a more prominent role in the income planning for pre-retirees within ten years of retirement. With the lifetime value of benefits topping $1 million for a married couple, Social Security has become a very material retirement asset for many people. Without the proper planning, it is not inconceivable that tens or even hundreds of thousands of dollars could be left on the table.

The mistake most people make is to wait until they are at the threshold of retirement to choose their Social Security benefit option. When they realize there are more than 180,000 alternative collection options, they may wish they had more time to plan. Between the system’s complexities and the incredible degree to which benefits can differ based on individual circumstances, most people are not prepared for the number of mind-numbing minutiae involved in exploring their options. Yet, unlike choosing Medicare options, which can be changed every year, once the choice of Social Security options is made, it is locked in for life.

Critical Decisions with Big Money Implications

The issue that is top of mind for most people is when to start taking benefits. Most people know they can begin collecting benefits as early as age 62 at a reduced payout. An increasing number of people are learning that, by delaying benefits to age 70, they can increase their payout by more than 30%. However, even that fundamental choice requires a thorough evaluation of a number of factors, including your health and your family health history, along with financial and family considerations.

The decision to delay benefits is also affected by the prevailing interest rates. In a low-interest rate environment, it might make sense to delay benefits because the increase in payments exceeds the growth of funds earning interest. In a higher interest rate environment, it might make sense to take benefits at full retirement age.

The more complicated issue involves planning around spouses – current spouse, past spouse, the Social Security decisions made by your one-time spouse, and whether any spouses qualified for full retirement benefits. Every year $10 billion in spousal benefits go unclaimed. There are at least a dozen different strategies that take advantage of loopholes for married couples, which can add tens of thousands of dollars to their lifetime benefit.

Social Security as an Asset Planning Tool

Less appreciated, and therefore often ignored as a critical planning issue, is the value of Social Security as a retirement asset and its impact on other assets in a retirement portfolio. The fact is, Social Security payments are significant enough that, for the average beneficiary, it would require an asset worth several thousand dollars to replace it. For most people, that would comprise a significant portion of their total net worth.

However, unlike other assets, the unique investment characteristics of Social Security make it a highly desirable asset, capable of providing a hedge against many of the risks associated with retirement portfolios. Because the value of Social Security benefits increases when the value of retirement assets decreases, it is considered a hedge against the rest of the retirement portfolio. Also, because the value of Social Security is calculated based on life expectancy, its value increases further for people who live beyond life expectancy. And, because its payments are inflation-adjusted, its value increases even further during periods of higher inflation.

The bottom line is Social Security should be viewed as an asset allocation tool that can form a natural hedge for a retirement portfolio. Although it can’t be treated like liquid assets, which can be managed based on changing assumptions, the bond-like Social Security asset can and should play a key role in spending and income distribution strategies, including determining the best time to start taking benefits. With that kind of hedge in place, it could make sense to maintain a higher exposure to equities until benefits begin at age 70 and beyond.

Incorporating Social Security into Portfolio and Income Planning Decisions

The type of retirement income planning required to account for the role of Social Security as a portfolio hedge or to maximize income must start well before your anticipated retirement date. There are numerous factors to consider that can impact portfolio decisions before and after retirement. With hundreds of thousands of dollars at stake, a planning delay can prove very costly.