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A Retirement Planning Strategy Goes Away

With little fanfare, Congress has put an end to a valuable Social Security planning technique for married couples.

Last week, President Obama signed the Bipartisan Budget Act of 2015. As the law’s name suggests, it is mainly a federal budget deal, but it also included some major changes to Social Security. The update with arguably the largest impact is the termination of the “file and suspend” strategy, which had gained popularity with many married couples for retirement planning purposes.

It is common knowledge that waiting until age 70 to collect Social Security benefits will lead to higher monthly payouts than claiming benefits immediately upon turning 62. The file and suspend tactic allowed married couples to effectively have their cake and eat it too.

Say two spouses had become eligible for Social Security, with the higher earner having reached full retirement age (FRA). With file and suspend, the higher-earning spouse would file, but “suspend” his or her benefits - that is, stop drawing benefits in order to continue accruing deferral credits. Meanwhile, the lower earner would file and begin collecting spousal benefits for up to 50 percent of the higher earner’s benefit amount, less any early election reduction if applicable, as opposed to collecting the smaller net benefit to which the spouse would be entitled on his or her own record. At age 70, the higher earner would reactivate his or her benefits, since she or he would no longer benefit from delaying. (My colleague Melinda Kibler gave a more detailed example in her article about Social Security and Medicare planning last fall.)

Under the new rules, this strategy will no longer work. That’s because, once the provisions go into effect, filers who suspend their benefits will also cut off any spousal or dependent benefits based on their record, known as auxiliary benefits. While the ability to suspend benefits is not disappearing altogether, it seems obvious that lawmakers only want filers to make the election if there is a material change to their situation after submitting their Social Security application.

The file and suspend tactic is not the only Social Security strategy to go; the new law also puts an end to the practice of filing what was known as a “restricted application” for spousal benefits. In the past, filers who had reached FRA could start collecting only spousal benefits, leaving their own earned benefits to grow until age 70. Now applicants who file for benefits are automatically deemed to have filed for both retirement and spousal benefits concurrently, and will automatically receive the greater of the two amounts.

Why the change? It is no secret that Social Security is struggling, and has been for some time. Social Security’s disability program was in the worst condition, with its cash reserves scheduled to be depleted sometime next year. This would have resulted in roughly a 20 percent cut in disability benefits, which Congress and the White House were eager to avoid.

Last week’s budget deal diverted funds from Social Security’s retirement program to help plug the disability gap until 2022. In turn, the changes to the rules for claiming retirement benefits should help reduce the overall impact on the Social Security retirement program. The Center for Retirement Research has estimated that file and suspend added $9.5 billion in annual costs that Social Security will now mostly avoid.

Is $9.5 billion a year a lot of money? Sure. Is the change enough on its own to keep Social Security afloat for very long? Probably not. As Taylor Swift eloquently puts it, “Band-Aids don’t fix bullet holes.”

From the government’s point of view, the law is simply a matter of closing “unintended loopholes,” as is stated in the text of the legislation. But while it may appear to be a fairly straightforward attempt to stave off the inevitable as far as Social Security funding is concerned, lawmakers and individuals alike need to remember that nothing in the world of Social Security is truly straightforward. In a system with so many moving parts, this kind of rule change is likely to have a variety of consequences, not all of them intended.

For instance, Laurence Kotlikoff, an economics professor at Boston University and director of the Fiscal Analysis Center, has suggested that the rule change could lead to a spike in divorce rates in the next few years. In an op-ed column, he explained that long-time couples who no longer have access to file and suspend could theoretically get divorced no later than two years prior to their FRA and become eligible to collect a full spousal benefit based on one another’s records. Once they reach age 70, they can start collecting their own retirement benefits and remarry.

While Kotlikoff’s point is valid, I don’t think this divorcing strategy will be widespread in practice, since there are other factors at play, such as the costs of divorce and remarriage, income tax consequences, insurance complications and estate planning concerns. Not to mention that a lot of people would probably prefer to stay married, regardless of the financial implications. However, Kotlikoff’s column does illustrate the kind of unintended consequences Social Security updates can create.

The budget deal also gives higher-earning ex-spouses an avenue for vindictive action. If a lower-earning ex-spouse files for a divorced spousal benefit on the higher earner’s record, the higher earner can elect to file and suspend, thereby cutting his or her ex-spouse off from spousal benefits for the duration of the suspension and leaving them to make do. Even someone with the purest of intentions may suffer from the updated rules. For instance, a filer who might have preferred to wait to collect benefits until age 70 will now face the choice of taking the benefit earlier or being unable to offer auxiliary benefits to family members who may have planned on them.

The real reminder these rule changes offer is that Social Security is, and has long been, frustratingly complex for the average person. Fortunately the law grandfathered in those who are currently taking auxiliary benefits in a file and suspend arrangement. The law also leaves a six-month window for anyone who has reached FRA to enact such a strategy under the old rules, with a May 1, 2016 cutoff.

For everyone else, the old file and suspend strategy is off the table, despite its previous place as one of many tools in the retirement planning toolbox. If you are nearing retirement age, or if you had planned to employ the file and suspend strategy but are no longer eligible to do so, this change is a call to action. You will need to reevaluate your Social Security planning, and overall retirement planning for that matter, and make any necessary adjustments. Meanwhile, those who continue to be eligible should avoid rushing out to file and suspend just because they are about to lose the chance; as with any Social Security approach, careful planning is key.

If you have not yet taken the time to devise your Social Security strategy, this change is just one of a variety of factors that you, and potentially your financial adviser, will need to bear in mind. Depending on your age, Social Security may look quite different by the time you approach retirement. The only guarantee is that it is unlikely to become simpler anytime soon.

If you enjoyed this article, be sure to check out Palisades Hudson’s book, Looking Ahead: Life, Family, Wealth and Business After 55, now available in paperback and as an e-book.

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