Understanding Social Security Retirement Benefits

Older clients often rely on CPAs for information and advice on the computation, reduction and taxation of Social Security retirement benefits. Because Social Security benefits are an important aspect of retirement planning, CPAs need to know how these benefits are determined. . This article * Shows how the Social Security Administration (SSA) computes retirement benefits and how this affects the decision on when to retire. * Discusses the SSA's retirement test and presents strategies on working during retirement without a benefits reduction. * Explains the taxation of Social Security retirement benefits and provides ideas to minimize the tax. A worker may retire earlier or later than the normal retirement age of 65. Early retirement occurs from 62 through 64; late, after the worker's 65th birthday. The primary insurance amount (PIA) is the monthly retirement benefit a worker who retires at 65 receives. The benefits of a spouse aged 65 (or under 65 and caring for, a child under 16 or disabled) and the benefits of a dependent child are 50% of the retired worker's PIA. The PIA for early retirees is reduced by .56% for each month of entitlement before normal retirement age; the maximum reduction is 20%, for retirement at 62. A spouse's benefits are reduced .69% for each month of entitlement before 65 to a maximum of 25% at 62. The PIA for late retirement is increased by .29% for each month of delay. The Social Security Administration might make two errors when determining a retiree's primary insurance amount: failure to post earnings subject to Social Security taxes to the workers account and computation mistakes. Posting errors can be spotted by completing Form SSA-7004PPC, Request for Earnings and Benefit Estimate Statement, available from Social Security Teleservice at (800) 772-1213. Those who periodically dispose of tax records should be advised to complete this form before doing so. After records have been discarded, taxpayers will be unable to check if earnings subject to Social Security have been posted properly. The Social Security Administration automatically computes a worker's PIA on retirement. The computation can be checked independently or by using published tables. [The National Underwriter Company, Cincinnati, annually publishes a SLIDE-O-SCOPE containing tables from which a worker's primary insurance amount may be obtained. The 1992 SLIDE-O-SCOPE can be purchased by calling (800) 543-0874. ] The sidebar on page 56 and exhibit 1, page 57, explain how to compute a worker's PIA. EARLY VS. NORMAL RETIREMENT Deciding when to retire comes down to a question of whether a worker is better off taking 80% of the PIA at 62 or waiting to get 100% at 65. Generally, the future value of full retirement payments begun at 65 will not equal the future value of reduced retirement benefits begun at 62 until many years in the future. Consider the example of the Bowman twins, Mike and David, born in 1930. The earnings of both since 1951 were subject to the maximum Social Security tax. Mike takes reduced benefits at 62, while David waits until 65 to retire. David's primary insurance amount is $1,117 per month or $13,404 annually; Mike's PIA is $893.60 ($1,117 x .80) per month or $10,723 annually. The future value of David's annual benefits compounded at 5% for 20 years is $443,216. The future value of Mike's annual benefits compounded at 5% for 23 years is $444,259. In other words, David will not catch up in total benefits paid to Mike for about 20 years. The higher the compounding rate, the longer the catch-up period. From an actuarial viewpoint, assuming everyone lives to the 22.5-year average life expectancy of a 62-year-old, it seems to make little difference whether retirement begins at 62 with reduced benefits or at 65 with full benefits. However, individuals in poor health or those able to produce aftertax returns higher than 5% may be better off opting for benefits at 62. …