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How spouses can maximize their benefits as some popular claiming tactics are eliminated Couples are recalibrating plans for when to claim Social Security benefits after a recent rule change. Congress recently put an end to a pair of Social Security-claiming strategies that couples have used to add tens of thousands of dollars to their lifetime retirement incomes. Now, spouses who want to maximize their benefits will need to become familiar with the next-best claiming strategies. For spouses who both have significant earnings, it will generally make sense for the higher earner to delay collecting benefits and the lower earner to collect early. For other couples in which one person has earned a lot more than the other, the changes may lead higher earners to file for Social Security earlier than they might have otherwise. The tactics being eliminated—known as file-andsuspend and a restricted application for spousal benefits—have made it possible for both members of a couple who are 66 or older to delay claiming Social Security based on their own earnings records in order to increase those payments, while at the same time, one spouse pockets a spousal benefit. But starting in about six months, people who file for benefits and then suspend them will also suspend Social Security payments for spouses and dependents that would be based on the same work record. Those who file and suspend before May will be grandfathered, which means their spouses will still have the option to claim a spousal benefit based on a suspended benefit. Meanwhile, workers who are younger than 62 at the end of this year will lose the right in the future to file a restricted application to claim only a spousal benefit and then switch to their own benefit later. Instead, when they apply for a retirement benefit, they will receive either their own earned benefit or a spousal benefit—whichever is higher. Those who are 62 or older at year-end retain the ability to file a restricted application at their full retirement age, as long as their spouse has suspended or is taking benefits. (Couples already using these strategies will be allowed to continue doing so.) For couples barred under the new rules from using either of these strategies, claiming decisions may become less complicated. But because claims will also be less lucrative, it’s more important than ever to use a coordinated strategy to squeeze the maximum from spouses’ combined benefits, says Michael Kitces, director of financial planning at Pinnacle Advisory Group Inc. in Columbia, Md. He recommends consulting with an adviser or using one of a growing number of websites that provide claiming advice. Here are basic guidelines for two types of couples: Dual-Earner Couples First, consider the options for a couple in which both spouses have work histories and the lower earner’s projected Social Security benefits are at least half that of the higher earner. While there are some exceptions, in this scenario both spouses will generally collect Social Security retirement benefits based only on their own earnings. (A spousal benefit is typically a maximum of half of what a worker is entitled to at his or her full retirement age.) While each spouse can start taking benefits any time between ages 62 and 70, it often pays for the higher earner to put off claiming as long as possible, preferably until age 70. Why? The longer you wait to claim, the higher your monthly payment. Take for example a couple where the higher earner, the husband, is entitled to $1,800 a month at age 62. He would be eligible for $3,151 a month if he waits until age 70 to claim, according to Social Security Solutions, which sells Social Security claiming advice. Should he die first, his spouse would typically collect his benefit rather than her own, as it would be higher. For a relatively high-earning couple who are the same age, one spouse has to live to 83 for the couple to come out ahead by delaying the higher earner’s benefits until 70, says Baylor University professor William Reichenstein, a principal at Social Security Solutions. Because the probability of one member of a 65-year-old couple reaching 90 is about 60%, Mr. Kitces says using such a strategy “is the odds-on bet.” In contrast, it generally makes sense for the lower earner—the wife in this example—to claim her benefit relatively early, at age 62 or 63. Why? The odds are less than 50% that both spouses will live beyond 81, Mr. Kitces says. Given that the low earner’s Social Security retirement benefit will stop when the first spouse dies, those odds argue in favor of the low earner claiming early, he adds. In this case, if the wife died first, the husband would simply continue to collect his own benefit. If the husband died first, the wife would get a survivor benefit based on his earnings rather than her earned benefit. Health and family history should also be a consideration. “With a married couple, the decision to delay benefits must be evaluated based on the life expectancies of both members of the couple,” says Mr. Kitces. “If both are in poor health, it won’t pay to delay much. And if both are likely to live well beyond 90, there can still be a value for both to delay to 70. But for most with average life expectancies, the most common strategy will be to delay the higher-earning spouse as long as possible but start the lower earning spouse’s benefits as early as possible.” Couples With One Primary Earner The math is different for couples in which only one spouse qualifies for an earned Social Security retirement benefit or where one spouse’s benefit is more than double the other’s. For them, it is often best for the high earner to wait to claim—but only until the low earner reaches full retirement age, which is 66 for those born between 1943 and 1954. To see why, consider Bob and Sally, who are both younger than 62 and whose respective monthly benefits at full retirement age are $2,685 and $500. Once Bob claims his benefit, Sally will become eligible for an $842 spousal supplement, which will bump her $500 benefit to $1,342, or half of Bob’s. For Sally to get the most from Social Security, she will want to start her spousal supplement at 66. Why? Spousal benefits stop growing at 66, so Sally won’t receive the delayed retirement credits that increase a worker’s benefit by 6% to 8% for each year he or she puts off claiming between 66 and 70. (But if she starts claiming before 66, her benefits will be reduced.) Under the new rules, Sally can’t receive her spousal supplement unless Bob claims his benefit. But if Bob takes his benefit before 70, he won’t receive the $3,544 maximum he’s eligible for at 70, which would force the couple to accept a lower survivor benefit. What should they do? If Bob is four or more years older than Sally, the decision is easy, says Joe Elsasser, founder of Social Security Timing, a software program advisers use to identify optimal claiming strategies. Bob should file at 70 and get the maximum he is entitled to. And Sally should claim her own benefit at 62—she’ll actually receive less than the $500 because she’s claiming early—and pick up her spousal supplement when Bob starts his benefits at 70. If Bob is less than four years older than Sally or is younger, the decision on when Bob should start his benefit becomes trickier. The couple will have to decide whether it is worth forfeiting some of Sally’s $842 spousal supplement—which sums to $10,104 a year—to secure a higher benefit for Bob. “If both live long enough it may still pay to delay,” says Prof. Reichenstein. Still, he expects many couples to decide against having the high earner delay all the way to age 70. With the changes in the rules, “the high earner is more likely to claim benefits earlier than he or she would have so that the low earner can add spousal benefits sooner,” Prof. Reichenstein says.
The Case for Minimizing Risk in Your Bond Holdings The sky didn’t fall, after all. At its September policy meeting, the Federal Reserve decided not to raise interest rates. Had it done so, higher rates would have translated into a loss of principal, at least on paper, for bondholders. (When interest rates rise, bond prices fall.) But the apparently misplaced obsession with the Fed misses a larger point: A substantial rate rise isn’t the only way bonds can bite you. The other major danger is credit risk—that is, the possibility of default. And in my opinion, this is just as serious a threat to your nest egg. Over the very long term, the markets reward taking credit risk, but not by nearly as much as you might think. From the start of 1926 to Sept. 30, 2015, for example, long-term corporate bonds returned an annualized 6.00% on average, compared with 5.62% for safer long-term U.S. government bonds. And this thin margin over the long haul disguises occasional short-term costs—sometimes substantial—for owning corporate bonds rather than government bonds. In the first 10 months of 2008, for instance, long-term corporates lost 15.8%, while long-term government bonds eked out a 0.3% positive return. Misplaced risk The message is crystal clear: Financial risk isn’t just about the possibility of sustaining significant losses. It’s also about the possibility that those losses show up when you can least afford them, as they did for many investors in the dark days of 2008 and 2009. The risk in your portfolio belongs on the equity side; the bonds in your portfolio are there for safety, not yield. They’re the dry powder that will see you through tough economic times and enable you to scoop up stocks at the accompanying fire sale; if they’ve taken a big hit along with your stocks, they won’t do you much good. This is why I believe in avoiding credit risk in your fixed-income portfolio—not just corporate bonds, but lower-grade and longer-term municipal bonds, too, which also got hammered during the last crisis, mainly because of their limited liquidity. This, in turn, informs the choice of fixed-income assets. Since so-called total bond index funds—which, to varying degrees, reflect the broad bond market—consist mainly of high-grade government debt, they’re dandy for the fixed-income pool of the average investor. But with a little effort, you can do better. To see just how badly credit risk can bite even a total bond index fund, we’ll focus again on the first 10 months of 2008. Let’s look first at the Barclays U.S. Aggregate Bond Index, the benchmark for most total bond index funds. During that period, the total return for this index, which includes corporate as well as Treasury bonds, was negative 3.2%—not horrible, and certainly a lot better than equities did then. On the other hand, a Barclays index of intermediate-term Treasury issues with roughly the same average maturity had a positive return of 5.3%. But woe unto those who reached for yield by focusing on corporate bonds. A Barclays index of high-grade, intermediate-term corporate bonds returned negative 11.6%, and a Barclays index of intermediate corporate bonds that concentrates on notes below investment-grade status returned negative 23.7%. My advice: Avoid, if possible, bond funds altogether, in part to save yourself the fees, and I would limit my fixed-income holdings to those with a government guarantee—Treasurys and certificates of deposit (assuming you stay below the $250,000 guarantee limit for the latter). Pick an average maturity that reflects your risk tolerance and start a ladder—a range of holdings with staggered maturities, which gives you the opportunity to reinvest money from maturing securities as you see fit, or take the cash if you need it, at regular intervals. Let’s say that because you’re worried about the prospect of rising interest rates, you want to keep the average maturity of your holdings at two years or less. Purchase equal amounts of one-, two- and three-year Treasurys and CDs, and roll the securities that mature each year into new three-year securities; that way you’ll always have some holdings maturing every year. If you need cash to live on or to buy stocks on the cheap, you can sell the Treasurys. CDs are more costly to liquidate, particularly if they’re in a brokerage account, but you can cash out of them as they mature rather than roll them over. You come out ahead in a couple of ways with this strategy, as opposed to buying a bond fund. First, if you never have to sell a CD before maturity, you’ll earn about 0.6 to 0.7 percentage point more on them in annual yield than you would on a Treasury of comparable maturity. And second, why pay even the slimmest of fees on a bond fund when you can buy Treasurys at auction at no cost? (You can buy bonds at auction without fees at the government website TreasuryDirect.gov or, with a large enough account, at many discount brokerage firms.) Not for everyone There are a few caveats and wrinkles here. In most cases, you’ll need at least a $100,000 portfolio to make this strategy worthwhile (especially if you’re paying even a small brokerage fee to purchase Treasurys at auction). For smaller amounts, the percentage of your assets that you’ll pay for a bond fund’s fees won’t amount to very many dollars. The young 401(k) investor, for example, would do well to purchase a bond fund, or better yet, a low-fee target-date fund. Second, if you have substantial taxable assets, then you might want to lower your tax burden by investing perhaps 30% to 40% of your fixed-income portfolio in a short-term or intermediate-term municipal-bond fund, preferably with an expense ratio of 0.20% or less. For most folks, the biggest threat to their retirement nest egg is that they’ll abandon their chosen strategy when the going gets tough; if your portfolio lets you sleep at night, you’re more likely to succeed. And in tough times there’s no better sleeping potion than the bonds issued or guaranteed by Uncle Sam.
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