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Practice Management

Many government retirement benefits are taken for granted by advisors, but still confuse clients. Here's what needs special attention.

This Practice Management article is intended for financial advisors only (registered representatives of broker/dealers or associated persons of Registered Investment Advisors).
 

Advisors are unquestionably becoming more knowledgeable at coaching and advising clients on planning their Social Security retirement choices.

But even as their skill level advances, advisors must remember not to assume that clients know as much as they do. As in any field of knowledge, it is often challenging for an expert to communicate complex concepts with a beginner in an effective manner.

Indeed, clients may—surprisingly to some advisors—be confused or totally in the dark about these Social Security concepts:

Spousal Benefits
Yes, spousal benefits may be Social Security 101 for advisors, but remember this is totally new to many clients. This most fundamental benefit and feature of the system, that individuals can collect a retirement benefit based solely on the work history of their spouses, sometimes come as a revelation.

An even bigger revelation may be the fact that persons collecting a spousal benefit never need have paid even one penny in Social Security taxation via payroll taxes. They are still eligible for lifetime benefits solely based on the work history of their spouses.

Survivor Benefits
Both the fact that there are survivor benefits and some features of the benefit confuse clients. Surviving spouses may be eligible for benefits which are significantly higher than they were receiving previously when their husband or wife was still alive.

The rules governing survivor benefits, although similar to normal spousal benefits, are different enough to induce confusion. For example, we drill into clients heads that the earliest age to claim benefits is 62. Not so with survivor benefits, which can be claimed as early as age 60.

Divorced Benefits
Some clients are unaware that they may be eligible to collect benefits based on the work history of an ex-spouse. Benefits are similar to spousal benefits and eligibility depends on a number of factors including length of marriage (at least 10 years) and current marital status (unmarried).

Happily for some divorced clients, there is no need for the ex-spouse to become involved in the process. The Social Security Administration processes the claim behind the scenes and the ex-spouse never even knows that these benefits are being paid out.

The Social Security Statement
Available online, the statement prominently features the most important information to clients: the size of the benefits they are projected to collect. Specifically, the statement lists the estimated benefits for three milestone ages: 62, 66, and 70. 62 is the earliest age to file. 66 is full retirement age (for most baby boomers) and 70 is the latest age at which one could still collect delayed retirement credits.

Although the meaning of these estimates may be crystal clear to advisors, I have encountered clients who significantly misinterpret the meaning of these estimates. This can seriously skew their claiming strategies and retirement income planning in general.

Consider a statement which lists a prospective retirement benefit of $1365 at age 62, $1790 at age 66 (full retirement age), and $2363 at age 70. Some clients mistakenly interpret this to mean that their benefit would be $1365 if they filed at any age from 62 to 65 and $1790 if the filed at any age from 66 to 69.

They may not understand an essential feature: that the benefits are adjusted in a step-wise fashion month by month as opposed to ratcheting up only at 66 and 70. The exact calculations are based on the full retirement age (66 for most baby boomers) benefit, which is then modified up or down to calculate the case of either a delayed or an early benefit claim.

Taxes on benefits
It shocks some recipients, and certainly annoys most, that their Social Security benefits may be taxed.

Since 1984, Social Security benefits have been subject to taxation. While the details are complicated, as much as 85% of Social Security benefits could be subject to federal income tax. The taxes depend on if, and by how much, a household’s special Modified Adjusted Gross Income for the year is greater than $32,000 for a couple or $25,000 for a single person filing.

One consolation, albeit small, is that all the federal income taxes collected from Social Security benefits stay in Social Security. Instead of being dumped into the general fund of the U.S. Treasury like most taxes, the income taxes on Social Security benefits are instead funneled back into the Social Security Trust Fund as a minor contributor to overall program revenues.

These are just a few of the topics which advisors may take for granted but which can surprise clients as they encounter the complex world of Social Security for the first time. Don’t assume anything. Keep it simple.

And try to approach your clients with the mind of a beginner.

-by Paul Norr
Paul Norr is a certified financial planner with Bucks County Financial Planning Group in Thousand Oaks, Calif.

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