Social Security benefit planning.

In order to be entitled to Social Security retirement benefits, an individual must be insured. As a general rule, fully insured status is obtained once the individual acquires 40 quarters of coverage. Full benefits are available at age 65, with reduced benefits available at age 62. There also are increased benefits available if payments are deferred beyond age 65.

A natural instinct is to commence payments as early as possible, because payments will cease on a worker's death. Indeed, it is generally assumed that a worker will be better off electing early payments at age 62, unless the worker lives beyond age 76. However, earned income can reduce, and even eliminate, the early benefits; up to one-half of the benefits may be subject to income taxation. Both of these possibilities should be taken into account by the financial planner, who should determine the likelihood of a client's continuing to have earned income before making a recommendation to elect early payment.

The simplest and most efficient way of assisting a client in determining prospective benefits is to request an earnings history from the Social Security Administration. This information can be obtained by filing Form SSA-7004-PC, Request for Earnings and Benefit Estimate Statement. This form is available at any Social Security office or can be obtained by calling 1-800-234-5772.

The maximum annual retirement benefit for 1991 was $12,275. If a worker decides to start receiving payments prior to attaining age 65, the maximum annual retirement benefit is reduced. The schedule above illustrates the benefit reduction.

In other words, the decision to elect early payments at age 62 initially turns on the life expectancy of the worker. The worker will receive 80% of the age 65 benefit for an additional three years (during ages 62-64) at the expense of forgoing 20% of the full benefit entitlement at age 65 and thereafter. Generally, once the benefit is commenced, the amount is fixed; the only adjustment will be for cost-of-living increases.

Social Security recipients may lose all or a portion of their retirement benefits if they have earned income from wages or self-employment. In 1991, there were basically three income limitations.

* Under age 65: $7,080. * Ages 65-69: $9,720. * Age 70 or older: no limit.

For workers under age 65, any earned income above the limitation reduces Social Security benefits by $1 for every $2 of "excess earnings," i.e., earnings in excess of $7,080. At age 65, the benefit reduction becomes $1 for every $3 of "excess earnings," i.e., earnings in excess of $9,720. This limitation is applied for each year benefits are received and are subject to cost-of-living adjustments. At age 70, there is no limitation on earned income.

Under current law, a worker will receive a so-called delayed retirement credit for each year payments are deferred beyond the normal retirement age. These credits are measured based on the year the worker attained age 62 and will essentially increase the monthly benefit by the percentage shown in the chart above.

A common financial planning technique is to determine how long it will take a worker to recover the benefits that would be payable at ages 62-64 if the worker waits until age 65 to receive the higher benefit. Example: A worker is entitled to receive the maximum benefit of $12,275 at age 65 or $9,820 at age 62 (i.e., 80% of $12,275). If the worker elects early payments at age 62, total payments of $29,460 will be paid during the next three years. The cost of the election is that the benefit payable at age 65 will remain at $9,820, a difference of $2,455 from the full age 65 benefit. The break-even point is generally calculated by dividing the ages 62-64 benefit of $29,460 by the difference of $3,455. In this case, the hypothetical break-even point would occur 12 years after the worker's sixty-fifth birthday.

This example suggests that the benefit of the age 62 election will be lost if the worker lives beyond age 76. However, this calculation does not consider the present value of receiving the benefits early. Assuming a 10% discount rate for the excess benefit of $2,455 received during the 12-year period, the worker will receive only $16,728 during ages 65-76, obviously less than the $29,460 received during ages 62-64.

  Age benefits   Percentage of   1991 maximum annual
     begin       age 65 benefit    retirement benefit
      62             80.0%               $ 9,820
      63             86.7%                10,642
      64             93.3%                11,453
      65           100.0%                 12,275
   Year worker       Yearly
  attains age 62   percentage
   1979-1986         3.0%
   1987-1988         3.5%
   1989-1990         4.0%
   1991-1992         4.5%
   1993-1994         5.0%
   1995-1996         5.5%
   1997-1998         6.0%
   1999-2000         6.5%
   2001-2002         7.0%
   2003-2004         7.5%
   2005 or after     8.0%