3 things that undermine Social Security benefits

Social Security is an important part of the retirement picture for millions of Americans, both young and old. According to a recent Gallup poll, 25 percent of Americans ages 18 to 29 and 43 percent of those ages 50 to 64 expect Social Security to be a major source of retirement income.

The average monthly retirement benefit for Social Security recipients was $1,325, as of July 2017. That may not go far if you’re facing mounting medical expenses or still paying off a mortgage in your later years. You may be dealt a further blow if your benefit amount is smaller than you expected.

[See: 9 Dividend ETFs for Reliable Retirement Income.]

There are several things that could threaten the size of your Social Security check. As retirement nears, it’s important to understand how certain choices can affect these critical benefits.

Timing matters. One of the most important questions for seniors is when to begin drawing Social Security. You can begin taking benefits as early as 62 or wait until full retirement age, typically 66 or 67 if you were born after 1943. Delaying benefits until age 70 is a third option. For each year you delay benefits ebyond full retirement age, your benefit amount increases by 8 percent until you hit you reach your 70th birthday.

Renee Kwok, president and CEO of TFC Financial in Boston, says the financial cost of claiming benefits before reaching full retirement age, typically 66 or 67 if you were born after 1943, may be high – even more so for someone who’s healthy and is likely to surpass standard life expectancies.

A 62-year-old who starts claiming Social Security today may see monthly benefits permanently reduced by 25 percent or more, Kwok says. A monthly benefit of, say, $1,000 at full retirement age becomes $750 for claiming benefits early. That's an annual loss of $3,000 or $60,000 less in total benefits over 20 years. If benefits increase 2 percent annually for cost-of-living adjustments over those two decades, the price tag for claiming early could climb to $73,000.

When you do the math, you might wonder why anyone would ever consider taking Social Security early to begin with. Kwok says there are two main drivers: poor health and an immediate need for income.

If you have significant health issues, taking benefits early may seem like the logical choice, but you still have to think long term, says Hunter Unschuld, a financial advisor with Fractal Profile Wealth Management in Albuquerque, New Mexico, and the founder and CEO of The American Society of Fiduciary Education.

RELATED: Check out these states with the oldest retirement ages:

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States with the oldest retirement age
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States with the oldest retirement age

Nebraska

Avg. retirement age: 65

New Jersey

Avg. retirement age: 65

Massachusetts

Avg. retirement age: 65

Connecticut

Avg. retirement age: 65

Wyoming

Avg. retirement age: 65

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[Read: 5 Common Mistakes Investors Make With Social Security.]

“Maximizing your Social Security benefits requires you to gamble on your health and life expectancy,” says Unschuld, adding that the break-even pointfor total Social Security benefits received is about age 80 to 81. When you compare starting your benefits at age 62, age 66 and age 70, it’s this 80 to 81 mark where your total benefits received will be equal. If you only live to 85, you’ll receive more benefits if you’d delayed until age 70 than if you started benefits at age 66 or age 62. The longer you live, Unschuld says, “the greater the total benefits received if you delayed to age 70.”

Timing is also important for married couples who are trying to coordinate their benefits together. David Peterson, a certified financial planner and managing director at United Capital in Denver, says it typically makes sense for the spouse receiving the smaller benefit to take Social Security at age 62, while the higher earner delays until age 70. He says couples also have to consider their health. If the higher wage earner takes benefits early, the surviving spouse’s benefit would also be reduced.

Continuing to work. Drawing Social Security early while continuing to work can deliver a double whammy to your benefits temporarily. Taking benefits while still working means in most cases, you may have to pay some of those benefits back to Social Security, says Ben Barzideh, a wealth advisor at Piershale Financial Group in Crystal Lake, Illinois.

In 2017, working seniors who claim Social Security ahead of their full retirement age can earn $16,920 per year, with no reduction of their benefits. For every $2 earned over that amount, $1 in benefits is withheld. Once you hit your full retirement age, the restrictions ease. The threshold climbs to $44,880, and $1 in benefits is withheld for every $3 you earn over that amount.

You do get those benefits back once you reach full retirement age, but it’s still a wise move to keep track of your earnings in the meantime. Aside from having your benefits reduced temporarily, earning too much while claiming Social Security could make a portion of your benefits taxable. Up to 85 percent of your benefits may be subject to federal income tax, depending on your income and filing status.

Barzideh says contributing to a traditional individual retirement account could help offset any potential tax consequences if you’re able to deduct your contributions. Remember, however, that once you reach age 70 ½, you’re subject to required minimum distributions with a traditional IRA. Contributing to a Roth IRA while working and receiving Social Security benefits wouldn’t offer any tax benefit in the short term, but you’d be able to withdraw that money tax-free once you stop working. And a Roth doesn't require taking distributions at all.

Medicare premiums. Medicare eligibility begins at age 65, and if you’re taking Social Security, your premiums are automatically deducted from your benefits. Joseph Roseman, managing partner of O’Dell, Winkfield, Roseman and Shipp in Charlotte, North Carolina, says Medicare premiums are a small but important part of retirement income planning.

“The standard premium for part B is $134 month in 2017, but depending on your income, your premium may be as high as $267,” Roseman says. One strategy for keeping premiums lower, he says, is to accumulate tax-advantaged assets, such as a Roth IRA or a permanent life insurance policy. When distributed properly, both “will generate income tax-free, which won’t affect your Medicare premiums.”

[See: The 9 Best Municipal Bond Funds for Tax-Free Income.]

Qualified charitable deductions are another tool seniors can use to minimize the impact of Medicare premiums on Social Security benefits, Peterson says. This strategy involves having your IRA custodian make a charitable donation on your behalf using funds from a required minimum distribution. “By doing this, you essentially get a tax deduction for the charitable contribution, even if you don’t itemize,” Peterson says. Plus, because the person never received the money from the required distributions, "it can help avoid those stealth taxes – like an increase in Medicare premiums.” 

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