Spousal-benefit calculations are more complicated than you think

My mailbag continues to fill up with questions about Social Security-claiming strategies. I have to admit that no matter how much I think I know about this subject, I always learn something new, thanks to your detailed questions. So please, keep them coming.

There seems to be a lot of interest in how spousal benefits are calculated. This is a great opportunity to lift the curtain on the formula that the Social Security Administration uses to arrive at a benefit amount.

When a worker files for retirement benefits, the worker's spouse may be eligible for benefits based on the worker's earnings.

The spousal benefit can be as much as half the worker's benefit, but it isn't always a simple matter of dividing by two; it also depends on what age the spouse files.

First, here's a a key definition.

The primary insurance amount, or PIA, is the benefit amount that a worker would receive if he or she elected to begin receiving retirement benefits at normal retirement age. It doesn't include the additional 8%-per-year delayed retirement credit the worker earns by postponing claiming retirement benefits until 70.

BREAKING IT DOWN

If a spouse is eligible for a retirement benefit based on his or her own earnings — and if that benefit is higher than the spousal benefit he or she would receive based on the partner's work record — the individual receives the full retirement benefit. Otherwise, Social Security pays the spousal benefit.

Here is an example of how the Social Security Administration calculates the benefit for a woman who collects retirement benefits early at 62 on her own earning record and then qualifies for spousal benefits at a later age once her husband files for his benefit.

Let's say the wife's PIA is $1,000 a month. She files for her own benefit at 62 and receives a reduced retirement benefit of $750 — a 25% reduction because she claimed four years before her normal retirement age.

And let's also assume that her husband has a PIA of $2,500 a month at his normal retirement age of 66.

Once he files for benefits, she is eligible to receive one-half his PIA at her full retirement age. That amount — the full spousal rate — would be $1,250.

But because she claimed her own retirement benefit early, it will also affect how much she receives as a spouse.

First, Social Security subtracts the wife's PIA of $1,000 a month from the full spousal rate of $1,250. The resulting $250 differential is then added to her reduced retirement benefit amount of $750 to arrive at $1,000.

That is the new monthly amount that she will receive in combined retirement and spousal benefits once her husband files for his retirement benefits. It is a combination of her reduced retirement benefit because she collected early and the differential between her full retirement benefit and full spousal benefit at normal retirement age.

Even if he delayed collecting his retirement benefits until 70, which would boost his benefit to $3,300 a month, it wouldn't increase her spousal benefit. Remember, her spousal benefit is based on his PIA at full retirement age, not including any delayed-retirement credits.

However, if he dies first, she will receive a survivor benefit worth 100% of what he received during his life, including the delayed-retirement credits. And as long as she is at least normal retirement age at the time, her survivor benefit won't be reduced even though she collected her own retirement benefit early.

SEPARATE POTS

Think of retirement benefits and survivor benefits as two separate pots of money.

And therein lies the secret of Social Security-claiming strategies for married couples. The primary goal should be for the main breadwinner to secure the largest retirement benefit possible because it translates into the maximum benefit for a surviving spouse.

It really doesn't matter if the lower-earning spouse collects reduced benefits early, because he or she is still likely to step up to larger survivor benefits.

This is just one of the issues that we will discuss in our third and final webinar on Women and Investing, scheduled for Oct. 30. Don't miss it.

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