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Major Social Security change reduces benefits for couples, divorced individuals

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Like a thief in the night, Congress recently approved a significant reduction to Social Security benefits for married and divorced couples. Few noticed because the revision was included in the Bipartisan Budget Act of 2015 approved in November to avoid a government shutdown.

There was little publicity about the proposed change before the vote and little media coverage about the eventual impact on retirees.

Specifically, the act eliminated a claiming strategy that allowed one member of a couple to receive a spousal benefit while deferring his or her own Social Security benefit and allowing it to increase. Prior to the change, a person could file for benefits and then immediately suspend those benefits. The person’s spouse could then use a restricted application to collect spousal benefits while deferring his or her own benefit until age 70.

According to Social Security Solutions, a company that makes Social Security analysis software, “The catch to the new legislation is that when a client suspends his benefit, all benefits paid from his record are also suspended. Previously, a beneficiary could suspend benefits while a spouse and young children could continue collecting benefits from his record.”

The biggest losers are likely divorced individuals, who under the old rules could have used a restricted spousal benefit to allow them to delay their own benefits and pick up the additional credits until age 70. “Divorced people who wanted to take a spousal benefit while their own benefit earned delayed retirement credits will be out of luck,” notes a report in kiplinger.com. Many of these individuals have limited retirement resources that now have been significantly reduced.

The change is also likely to disproportionately hurt women, because of their longer life expectancies and rising divorce rates, notes Mary Beth Franklin in an article for investmentnews.com.

Congress portrayed the change as closing a loophole. But the Social Security Administration was fully aware of the strategy and encouraged those eligible to file in the manner that was most advantageous.

For example, according to information from the Social Security Administration published prior to the change, “If you have reached your full retirement age and are eligible for a spouse’s or ex-spouse’s benefit and your own retirement benefit, you may choose to receive only spouse’s benefits and continue accruing delayed retirement credits on your own Social Security record. You then may file for benefits later and receive a higher monthly benefit based on the effect of delayed retirement credits.”

As a result, many people planned their retirement based on those formerly existing regulations. The strategy was used extensively and the change has the potential to significantly reduce overall Social Security benefits for a large portion of the population.

As an example, let’s consider an imaginary couple named Bill and Mary who are both the same age and who earned the same Social Security benefit of $2,000 monthly. At his full retirement age of 66, Bill planned to file and suspend his benefit until age 70. That made Mary eligible for a spousal benefit of $1,000 a month. In the meantime, Mary planned to allow her own earned Social Security benefit to accrue until age 70 when it would be worth $2,640 a month instead of $2,000.

In this example, the old rules allowed Mary to collect $12,000 a year in spousal benefits for four years — a total of $48,000 lost to the couple under the new regulations. In actual practice, some people would qualify for more than $1,000 a month in benefits and some for less.

Unfortunately, for many couples the total reduction will be far more than the spousal benefit. Losing the spousal benefit is likely to force many to tap into benefits earlier than planned, meaning that in addition to the lost spousal benefit they will receive a significantly reduced monthly benefit for the rest of their lives. Lifetime survivor benefits would also be reduced as a result of the earlier filing. The total reduction of household income for a couple could potentially reach hundreds of thousands of dollars.

The new regulations take effect in May. Those who turned 62 before the end of 2015 can still file under the old standards.

While these changes will create a significant financial reduction in retirement income for many, they do little to offset projected future deficits in Social Security spending. According to Stephen Goss, chief actuary of the Social Security Administration, “this provision is expected to have essentially no net cost effect through 2025.” The move will decrease the agency’s long-range actuarial deficit by 0.02 percent, he notes.

Instead of slashing benefits, “a much better method to get Social Security in order, should it prove to be in crisis, would be to change the way Social Security taxes work,” wrote Terasa Ghilarducci in an article for The Atlantic. “As of now, taxpayers contribute money into Social Security, but only for every dollar they earn up to $118,500 — any dollar earned beyond that isn’t subject to Social Security taxes. Getting rid of this cap would reduce 70 percent of that expected deficit 75 years from now.”

Unfortunately, even though most people are not aware it happened, approval of the budget act significantly reduced overall retirement income for many Americans in the years ahead.

Flint Stephens is a licensed investment adviser representative.

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