Early this Friday morning, the Senate passed a bipartisan budget agreement to extend the government debt ceiling and avert a default. At this hour, the agreement is headed to the White House where the President is expected to sign it.
While the initial headlines of this Bipartisan Budget Act of 2015 will likely address the raised debt ceiling and the avoidance of default, the Act makes major changes to Social Security benefits and claiming strategies. Over the coming days and weeks, we expect there will be more media coverage of these changes to Social Security strategies.
Desiring to be in front of any questions and to determine if any immediate action is necessary for our clients, we spent considerable time over the past 48 hours understanding the new rules and then carefully considering the planning implications (as best we could in a short time). Admittedly, these changes were a surprise to nearly everyone in the financial planning industry as there was little to no mention of such changes in any previously proposed or discussed legislation.
What Are These Major Changes to Social Security?
We have commonly recommended loophole-exploiting strategies when discussing Social Security planning with clients in the past. In fact, the specific section (831) of the current bill related to Social Security changes is titled “Closure of Unintended Loopholes”. That said, these loophole closures still come as a surprise and we are still digesting all the implications. At the end of the day, it is estimated that the changes will cost Americans $9.5 billion each year but shore up the Social Security future funding by that same amount each year.
In short, three useful claiming options/strategies (loopholes) will be amended or eliminated:
1) File and Suspend. This strategy allowed anyone who reached full retirement age (presently age 66) to file for their own benefit and immediately suspend. While it seems of little value to file for benefits and immediately suspend them, the advantage of the strategy was that it enabled one spouse to collect spousal benefits based on the earnings history of the other spouse who filed and suspended. The suspending spouse would then continue to earn additional credits of 8% per year, while waiting to take his/her own benefit.
For example, assume Jim and Pam are married and Jim turns 66. Assume also that Pam did not work long enough to earn Social Security benefits of her own so without Jim filing for his benefits, Pam is not eligible to receive any benefits. Jim wants to defer benefits until age 70 so he can increase his lifetime benefits (and survivor benefits of Pam) by 32%. The strategy here was for Jim to file and suspend his benefits which would allow Pam to claim based on Jim’s earnings history. Concurrently, Jim continues to accrue benefits at 8% per year until he eventually claims his own benefit (at age 70 or earlier).
The new law ends the file and suspend strategy 180 days after the law’s enactment. Anyone currently employing this strategy or anyone who files and suspends before the end of next April (approximately April 27, 2016) will be permitted to continue using the strategy. Anyone who is not yet full retirement age by next April or who simply has not yet filed and suspended will no longer be able to use this option.
2) Restricted Application. Any spouse in a married couple is entitled to the greater Social Security benefit of a) their own benefit based on their own earnings history; or b) ½ of their spouse’s benefit – referred to as a spousal benefit (this is admittedly an oversimplification of the actual rules). The restricted application strategy allowed a spouse who reached full retirement age (again, presently age 66) to file a restricted application where he/she claimed the spousal benefit. By only claiming a spousal benefit, this spouse’s own benefit continued to accrue at 8% per year.
The strategy worked very well for two working spouses. Consider Pam and Jim again but assume Pam worked enough years to qualify for her own benefit and that they both just turned 66. Jim could either file regularly or file and suspend which, in turn, would allow Pam to file a restricted application. Pam immediately starts to receive her spousal benefit while her own benefit accrues for the next four years. At age 70 (or sooner), Pam files for her full benefit and her monthly payments increase to the higher payment that is based on her earnings history. There are many iterations of this strategy which is also referred to as the “Claim Now, Claim More Later” strategy.
With passage of the new law, the restricted application option is now only available to individuals who were born in or before 1953. Everyone born in 1954 or afterwards will no longer qualify to file a restricted application and, when filing, will be deemed to file for the greater of the two benefits described above.
3) Retroactive Benefits. This benefit option allowed someone who filed and suspended to later reverse their suspension decision and retroactively claim all the benefits which otherwise would have been paid had the individual never suspended the application in the first place. The technique proved useful for anyone who filed and suspended after age 66 and later regretted making that decision – generally because of dramatically deteriorating health that shortened life expectancy.
The option for retroactive benefits will now be eliminated – effective 180 days after the bill is enacted.
Do I Need to Do Anything Now?
There is no need for any immediate action although some action will be warranted within the next 180 days in specific situations. Although we cannot go through every possible scenario, we will cover some of the general circumstances below.
Widows/Widowers. Widows and widowers appear to face no changes to their many strategy options or to any benefits they currently receive.
Divorced Spouses. Divorced spouses born after 1953 will lose the option to claim benefits only on their ex-spouse’s earnings record (a version of the restricted application). Divorced spouses born in or before 1953 will be unaffected.
Anyone Already Over Age 70 or Who Will Reach Age 70 by Next April. There is no discernable impact for this group as you’ve hopefully already exploited all the potential loopholes.
Anyone Who Will Turn 66 Between Now and April 2016. Individuals in this group may want to take advantage of the file and suspend option before the strategy closes next April. The benefit depends on the circumstances but file and suspend will generally only be useful if your spouse has not filed for Social Security yet and is within 8 years of age.
Anyone Born In or After 1954. For this group, there is generally no immediate impact. You will lose the benefit of these Social Security loopholes but your claiming strategies will now be simplified when it comes time to claim. The optimal strategy in many cases will be to wait as long as possible to claim benefits.
Anyone Born Between 1950 and 1953, Currently Married, and Not Already Claiming Benefits. If you fall into this group, you still retain the restricted application option so there remains value in considering the different claiming options available to you and your spouse. In cases where both spouses qualify for a benefit based on their own earnings history, it will often now make sense for the lower earning spouse to file before the higher earning spouse and the higher earning spouse to file a restricted application at full retirement age.
Anyone Born Between 1946 and 1949, Currently Married, and Not Already Claiming Benefits. Depending on the age and earnings of your spouse, you’re likely to see little impact from the loophole closures. However, individuals in this group with a younger spouse (born in 1953 or earlier) who were waiting to file and suspend until said spouse reached full retirement age, should file and suspend within the next 180 days.
What About My Specific Situation?
We try to cover some of the general scenarios above but every situation is different which is what makes Social Security planning a valuable service in the first place. For those of you who are married and at or near full retirement age, we have likely already discussed your optimal plan of attack for Social Security claiming strategies. Many of those strategies are unchanged by the new law but if you are uncertain whether or how these changes impact you, we encourage you to reach out to us. You can call, email, or simply leave a comment below and we will get back to you.