Savvy husbands and wives spend a lot of time coordinating when to start taking Social Security to maximize their total benefits. But it’s just as crucial to plan for when that income is slashed after the first spouse dies. “Anytime a source of income is tied to the life of an individual, you need to look at the impact of mortality of that person,” says Paul Gaudio, a wealth planning strategist at Bryn Mawr Trust.
One silver lining in Social Security is that no matter which spouse dies first, the survivor keeps the higher of the two benefits. But you don’t get both, says Judith Ward, a senior financial planner for T. Rowe Price.
Social Security earnings test
If a higher-earning husband is the survivor, he will stick with his benefit for the remainder of his life while the lower earner’s benefit disappears. If the lower-earning spouse survives, she can switch to a survivor benefit worth 100% of what her husband was receiving or was eligible to receive at the time of his death—including any delayed-retirement credits he earned. (She’ll get a reduced survivor benefit if she claims it before her full retirement age.)
Boosting the survivor benefit is a key reason that experts recommend delaying claiming benefits until age 70, particularly for the higher-earning spouse. Racking up four years of delayed credits not only boosts his benefit by 32%, but it also hikes the survivor benefit for his widow if she outlives him. Consider a couple of the same age in which the higher earner delays claiming benefits until age 70 but then dies at 71. If his wife lives until 91, his boosted benefit will not be paid for just a single year, but for 21 years.
That can help the survivor mitigate the financial blow of losing her own benefit when she switches to the survivor benefit. When considering when to claim benefits, “really look at what’s optimal for the survivor benefit,” says Michael Weber, a partner at financial-services firm WeberMessick. “You could be giving away six figures if you don’t.”
Say the higher earner was eligible for a $2,000 monthly benefit and boosted it to $2,640 by claiming at age 70. Meanwhile, the lower earner claimed her own $1,200 monthly benefit at full retirement age. In their seventies, the same-age couple is bringing in a total of $3,840 a month from Social Security.
When he dies, the surviving spouse will switch to a survivor benefit worth $2,640, 120% higher than her own. (These numbers, of course, would be higher because of intervening cost-of-living adjustments.) Still, the total income from Social Security drops 31%.
But if her spouse hadn’t held off claiming to boost his benefit, her situation would be worse: She would switch to a survivor benefit that was about 67% higher than her own and would suffer about a 38% drop in total benefits. While it won’t mitigate all the financial pain, the higher benefit helps soften the blow.
The narrower the gap between a couple’s benefit amounts, the harder that financial punch will be when one benefit drops off. And the pain is most acute when both spouses bring in hefty benefits. Say both spouses qualify for a full benefit of $2,000 a month and both waited until age 70 to claim to boost their individual monthly benefit by $640 each. That puts their combined benefit at $5,280 a month. When the first spouse dies, that Social Security income will be cut in half, with no higher benefit the survivor can switch to.
How to replace lost Social Security income
While such a sharp drop in benefits is a scary thought, the good news is a couple can plan ahead before the surviving spouse faces that cliff. “The loss of a spouse is very traumatic,” says Marguerita Cheng, chief executive officer of Blue Ocean Global Wealth. It’s not ideal to make significant financial decisions while in the throes of grieving. “Planning gives you more choices and more control,” she says.
Buying an annuity vs. investing
A tricky obstacle, of course, is that you can’t be certain about when death will claim the first benefit. Considering each spouse’s health and family longevity may give you a rough idea. Once you have created a retirement income plan, review your plan on an annual basis to account for changes in assumptions or life events, says Nora Everett, president of retirement and income solutions at Principal Financial Group.
Couples should project out a couple of scenarios, assuming the lower benefit disappears sooner and later. How would you buttress the financial loss in each circumstance? It’s “all about trying to preserve assets to last through both lives,” says Ward.
Once you can envision the potential income gap, start looking for income spigots that could be turned on to fill it. If you have to turn to bigger retirement account distributions for the survivor, how will that affect the nest egg’s longevity? “Extra distributions might work in the short term, but you don’t want to threaten the nest egg,” says Cheng.
Perhaps an annuity could be purchased to restore needed cash flow. You could set aside a stash of cash that the surviving spouse could use to buy an immediate annuity that throws off the same amount as the lost benefit after the first spouse dies. Or you could consider buying a longevity annuity that will start paying out decades into the future, such as at age 85. Each spouse could buy one, or just the spouse likely to live the longest, with a rider to pay a death benefit if the couple guesses wrong on that point.
Life insurance may be another route to fill the gap, says Cheng, whose father chose that route to help provide for her mother after his death. Proceeds will go to the beneficiary tax-free when the insured dies, creating a pot of income to draw upon monthly.
Be sure to take taxes into account. “Look at the income gap and look at the resources you have,” says Cheng, and “look at the most tax-efficient way to fill it.” There’s no penalty for traditional IRA withdrawals after age 59½, but you do have to pay taxes. “You don’t want to take out too much and end up in a higher tax bracket,” says Cheng. Building up a pot of tax-free Roth money for the survivor to draw upon would help keep her tax bill in check.
As you plan, take a hard look at expenses—and delineate those that are essential and those that are discretionary. “There’s no magic to it,” says Everett. “Some of it is back to basics budgeting.” If total expenses are lower, you may not need to replace as much, or any, income from the lost benefit. But if you expect many expenses to remain about the same, get creative now about how to make up for the certainty that your Social Security income will decline when the first spouse dies.
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