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Federal budget deal contains surprise for retiring couples

Federal budget deal contains surprise for retiring couples

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Fed changes for retiring couples

When the federal government passed the budget late in 2015, it came at a cost for couples looking to maximize their Social Security benefits in retirement.

What the new federal budget means to Social Security benefits

On November 2015, the President signed into law the new federal budget (the Bipartisan Budget Act of 2015). Although this agreement avoids a potential government shutdown and keeps funds flowing to key programs, it comes at a considerable cost to retiring senior citizens who desire to maximize their benefits from Social Security. This surprise legislation contains provisions that effectively kill the File-and-Suspend and Restricted Application claiming strategies that were available for maximizing Social Security benefits.

The objective of the new law is consistent with a desire to reduce spending and extend the solvency of the Social Security system, albeit at the expense of future retirees. In analyzing the implications of the new law, this article will discuss the prior law, what has changed, and what it means for those couples that are at or near retirement. It will be important for those couples and their advisors to understand the changes and what can be done to mitigate the adverse effects of the law.

File-and-Suspend

The rule under prior law

At Full Retirement Age (FRA), a person who filed for benefits and then suspended receipt of those benefits would continue to accrue credits for delaying benefits until he or she started receiving payments. The delay could be up to age 70, and the person’s beginning benefit would increase by 8 percent for each year the person delayed receiving benefits.

Once a retiree filed for benefits, regardless of whether that person received payment currently or suspended payment to a later date, the person’s spouse became eligible for spousal benefits. This meant that at FRA a spouse could file for and receive spousal benefits (50 percent of the retiree’s Primary Insurance Amount) even though the retiree’s suspended benefit continued to earn 8 percent per year in delayed retirement credits.

The rule under the new law

When a person suspends benefits, he or she will not only suspend his or her own benefits, but any and all benefits payable to other individuals based on that person’s earnings record. In other words, the spouse will not be able to collect a spousal benefit during the time that the person’s benefit is suspended.

The new law provides some grandfathering of the prior rules. Persons who suspended benefits in the past or within the first 180 days after enactment of the law will fall under the prior rule, and will continue to fall under the prior rule until they reach age 70 or un-suspend benefits. Essentially this means that persons who turn age 66 before May 1, 2016 will be able to take advantage of the prior rule. Persons who turn age 66 after April 30, 2016 will fall under the new rules regarding the File-and-Suspend strategy.

Restricted Application

The rule under prior law

At FRA, a person who was eligible for both a spousal benefit based on the work record of a spouse and a retirement benefit based on his or her own work could choose to elect only the spousal benefit. In other words, they could restrict their application to the spousal benefit. While the role of File-and-Suspend was to allow someone else to get spousal benefits while the person delayed his or her own benefit, the purpose of Restricted Application was for a person to receive a spousal benefit currently while delaying that person’s own retirement benefit, which would continue to earn delayed retirement credits up to age 70. If by age 70 the person’s own benefit exceeded the spousal benefit, the person could switch to the higher benefit.

If a person filed for benefits before FRA (as low as age 62), the person was deemed to be filing for the highest current benefit, either their own benefit or their spousal benefit. However, at FRA the deeming rule was removed and the person could choose which benefit they wanted. This made the Restricted Application strategy possible.

The rule under the new law

The new law eliminates the opportunity to switch benefits by extending the concept of deemed filing all the way to age 70. Now, persons filing for benefits will receive the larger of the either the person’s own benefit or the spousal benefit. The new law does, however, phase in the extension of deemed filing over a four year period. Persons who turn age 62 before January 1, 2016 will continue to be able to take advantage of the Restricted Application strategy. Current FRA for these persons is age 66. Persons who turn 62 after December 31, 2015 will be governed by the new rule.

What the changes mean

Three sets of rules

The law creates three sets of rules for retirees. The first set applies to persons who are age 66 or older before May 1, 2016. The second set applies to persons who are age 62 or older before January 1, 2016 (persons who have reached or will reach FRA over the next four years). The third set applies to persons who turn age 62 after December 31, 2015.

If you have clients who are at or near retirement, or are over FRA and have not yet filed for benefits, it is important to contact them and make them aware of the changes in the law. The law provides a limited window of opportunity for many of these individuals. One method is to meet with a retiring couple and place each spouse on the table below in order to gain an understanding of the options available.

Social Security Election Choices for Currently Married Couples

Age
66 before May 1, 2016
62 before Jan. 1, 2016
62 after Dec. 31, 2015
File and Suspend
Available
Not Eligible
Not Eligible
Restricted Application
Available
Available
Not Eligible
New Rules
N/A
N/A
Apply

 

Consider the following examples

(1) Jack turned age 66 on November 1, 2015 and has not yet filed for Social Security benefits. His wife, Jill, turned 61 on August 1, 2015. Jill does not have sufficient work history to qualify for her own benefit and plans on taking a spousal benefit based on Jack’s work history. Jack plans to wait until age 70 to begin receiving his benefits. Jill wants the option to claim spousal benefits as soon as she turns age 62. If Jack files and suspends before May 1, 2016, Jill can file for spousal benefits in 2016 when she turns age 62 while Jack’s benefit will continue to accrue delayed credits until age 70. However, if Jack fails to file and suspend before May 1, 2016, Jill cannot receive her spousal benefit until Jack actually begins receiving his benefits.

(2) Sharon will turn age 66 (FRA) on February 1, 2016. Her husband, Rick, will turn 66 on July 1, 2016. Rick’s monthly Social Security benefit (based on his own work record) will be somewhat higher than Sharon’s benefit (based on Sharon’s own work record). Under the prior rules, the most advantageous method of claiming for this couple (assuming normal life expectancy of age 86) would generally have been for Rick to File-and-Suspend to age 70; for Sharon to file a Restricted Application for her spousal benefit then switch to her own higher benefit at age 70. However, under the new rules, Rick is not eligible to File-and-Suspend and have Sharon collect a spousal benefit based on his work record while his benefit is suspended (he turns 66 after April 30, 2016). Sharon, however, is eligible to File-and-Suspend (she turns 66 before May 1, 2016) and Rick is eligible to file a Restricted Application (he is over age 62 before January 1, 2016). Thus, although this couple cannot achieve the maximum lifetime benefit that they could have before the rule change, they can still employ a strategy that provides greater lifetime income than simply each of them receiving benefits on their own work records.

(3) Kenny and Mary are each currently age 60. As neither of them will be age 62 before January 1, 2016, both of them will be subject to the new rules.

Additional points to consider

File-and-Suspend affects singles as well

The new law also eliminates the ability to request a retroactive lump sum for all benefits between the date of the request and the date of suspension. Previously, the fact that a person Filed-and-Suspended meant that if he or she had a change of mind later (an unforeseen financial hardship or terminal illness diagnosis, for example), it was possible to retroactively claim all benefits going back to the date of the original suspension. Thus, File-and-Suspend created a hedge against unforeseen circumstances, and this was a valuable strategy for both married and single workers.

Without the File-and-Suspend strategy, the rules allow only up to 6 months for one to receive retroactive benefits. Hence, for workers who have reached or will reach age 66 before May 1, 2016 and who have not yet filed for benefits, it is imperative to File-and-Suspend before May 1, 2016 if they desire to preserve this hedge strategy.

Widow benefits are not affected by the new law

The new rules concern the interaction between worker benefits and spousal benefits, and do not include widow (and widower) benefits. Thus, widows will continue to have the opportunity to restrict an application to only widow benefits or only worker benefits and later switch to the other benefit.

The calculation of worker, spousal and survivor benefits remains unchanged

The new rules do not affect the determination of Average Indexed Monthly Earnings (AIME) or determination of Primary Insurance Amount (PIA). In other words, the underlying methodology of how benefits are determined remains unchanged. Also, there is no change in the factors that are used to calculate benefits that are claimed early or are delayed.

Does it still make sense to plan?

Definitely. With more retirees facing a reduction in lifetime benefit, couples need to analyze alternative income streams based on various filing dates and actuarially calculated life expectancies. Under the prior rules, the option to restrict an application to only spousal benefits gave the higher wage earner in a couple an incentive to delay benefits, building a larger survivor benefit for the often younger and lower-earning surviving spouse. A significant consequence of the new rules will be lowered survivor benefits for widows. Understanding and coordinating cash flows in retirement has become even more important. In particular, providing products that can offset lowered Social Security survivor benefits with the same lifetime guarantee as Social Security will be important. Life insurance, immediate annuities and deferred income annuities can play a major role in providing lifetime income for the generation now facing retirement.

- Written by David A Gresham, JD, CLU, ChFC
Advanced Markets Analysis Manager
Individual Division
American United Life Insurance Company®
a OneAmerica® company
One American Square
Indianapolis, IN 46206

Note: Any individuals used in scenarios are fictitious and all numeric examples are hypothetical and were used for explanatory purposes only. This material is provided for overview or general information purposes only. These concepts were derived under current tax laws. Changes in the tax law may affect the information provided. This is not to be considered, or intended to be legal or tax advice. For answers to specific questions and before making any decisions, please consult a qualified attorney or tax advisor.

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