Why Social Security Is So Hard to Get Right

With millions of Americans having put little or nothing aside for their own retirement, Social Security will continue to play a key role in keeping them financially solvent during their retirement years. But figuring out how to make the most of the Social Security benefits you're entitled to is hard, because you have so many choices that can have a life-changing impact on your finances not just for as long as you live but also for the loved ones who depend on you.

To make sure you get as much from Social Security as you deserve, it's essential to understand the ramifications of the choices you get to make. Later on in this article, you'll get some strategies to help you make a smart decision with your Social Security benefits. First, though, let's take a look at just how important it is that you get it right.

Social Security: From supplement to dependence
The original idea behind the Social Security program was to provide supplemental income, not primary income, for retirees. Before the program was enacted, people got by with a combination of savings and the retirement income that some received from employer pensions.

Yet now, Social Security has become a huge part of financial security for retirees. According to a recent study from the Economic Policy Institute, for around 60% of those who are 65 or older, Social Security makes up the majority of their income. For poor and lower-middle-class people in retirement, Social Security provides an average of more than 80% of their overall income, while even among middle- and upper-middle-class retirees, the figures average out to roughly half of all income. Only among the richest fifth of the retiree population do pensions and investment income dwarf Social Security as a way of meeting living expenses. Moreover, many upper-class people of retirement age are still working, adding to outside earnings.

The complexities of Social Security
Social Security seems simple on its face. The major decision you have to make is when to start taking benefits. Take them at standard retirement age, which is currently 66, and get a certain monthly amount. Choose age 62 instead, and you'll get 25% less per month. Wait until age 70, and you'll get 32% more.

But as simple as that sounds, not knowing how long you'll live makes it hard to choose the best option. Waiting until age 70 gets you the biggest monthly benefit, but missing out on four to eight years of payments means that those who wait play catch-up for a decade or more in most cases.

Moreover, Social Security decisions affect more than just you. If you're married, then your spouse's potential benefits are affected by your decision. The same is true for ex-spouses if you were married for 10 years or more and the ex-spouse never remarried. Moreover, if both members of a couple have had careers, the interplay between your own benefits and spousal benefits based on the other spouse's earnings history is hard to analyze.

Trying to duplicate Social Security
MetLife , Genworth Financial , and a host of other insurance companies have realized how big the monthly income gap is in retirement and have sought to take advantage of it by offering more immediate-annuity products. These annuities offer monthly payments for life just like Social Security, and they're a useful tool in fighting against the risk of outliving your savings.

Even businesses are jumping on board. Just last year, both Verizon and General Motors tapped these products to cover their pension obligations to tens of thousands of workers. By outsourcing the investment risk to Prudential , both GM and Verizon were able to define the full extent of their obligations rather than having open-ended pension liability for decades to come. You can do the same with your own investment risk by buying an immediate annuity, although low interest rates have reduced the amount of income you'll be able to generate from them.

Be smart
When to take Social Security may be the last huge financial decision you'll ever make. Rather than just making your best guess, take the time to understand all the ins and outs and analyze when you'll be best off getting benefits. The right answer will make your retirement a lot more comfortable.

For more details on strategies you can use on Social Security, be sure to read this article.

Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance. You can follow him on Twitter @DanCaplinger.

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