Future cost-of-living adjustments applied to larger base benefit
I guess it's true that great minds think alike. Over the past few weeks, I have received similar questions from several financial advisers asking if the delayed retirement credits that retirees accrue when they postpone collecting Social Security benefits beyond their full retirement age are compounded.
The short answer is no.
Workers who reach full retirement age in 2009 or later earn delayed retirement credits worth 2/3 of 1% per month for each month they postpone collecting Social Security benefits up to 70.
And in today's low-interest rate environment, the ability to earn a guaranteed, risk-free return of 8% per year is a huge advantage for retirees.
The delayed retirement credit wasn't always so generous. Prior to 1982, it was a mere 1% per year. Since then, it has gradually increased from 3% beginning in 1982 and then in 0.5% increments every two years starting in 1990 until reaching the statutory cap of 8% in 2009.
Consequently, you can see that a decade or two ago, there was little incentive to delay collecting Social Security benefits. But today's 8% annual incentive to postpone benefits up to 70 makes sense for many clients who are in good health and who have other assets to draw on before collecting Social Security.
As the current full retirement age is 66 for those born from 1943 through 1954, the maximum delayed retirement credit is now worth 32% (four years x 8%). That means if you wait until 70 to collect Social Security retirement benefits, they would be worth nearly a third more than your full retirement-age benefit, also known as your primary insurance amount or PIA.
For those born after 1954, the full retirement age is higher, starting at 66 and 2 months for those born in 1955 and gradually increasing to 67 for those born in 1960 or later. That means the maximum delayed retirement credit will be smaller in the future: only 24% in the case of those born in 1960 and later (three years x 8%).
“Do you know if the Social Security Administration gives a flat 8% a year on the PIA or is it compounded?” asked Janet Critchley, a financial planner and accountant with Brinton Eaton in Madison, N.J. “If it's a flat 8%, then the age 70 benefit would be 132% of the PIA, but if it is compounded, it would be a little higher,” Ms. Critchley noted.
Barry Kaplan, a wealth manager and chief investment officer with Cambridge Wealth Counsel in Atlanta, even did the math. He noted the future value of four years' worth of compounded retirement credits would be closer to a 36%.
The math is correct, but the policy is not.
Delayed retirement credits are not compounded, but the resulting larger benefit amount will still keep pace with inflation. Future annual cost-of-living adjustments will be applied to the bigger base amount, which includes the delayed retirement credits. That means a bigger bang for each annual inflation adjustment.
For example, if your PIA is $2,000 per month and you receive a 2% cost-of-living adjustment this year, you would receive an annual increase of $480. But if you had waited until 70 and your Social Security benefit is now worth 32% more, or $2,640 per month, that same 2% COLA would boost you annual Social Security income by about $634.
Remember, delayed retirement credits stop at 70, so it doesn't make sense to postpone collecting Social Security beyond then, even if you are still working.
But spousal benefits do not qualify for delayed retirement credits. Therefore, even if a husband delayed collecting his benefits until 70, the maximum spousal benefits that his wife can collect is based on half of his full retirement age benefit, not half of the larger amount.
However, survivor benefits are worth 100% of what the deceased worker received or was entitled to receive at time of death — including any delayed retirement credits (assuming the widow or widower waits until full retirement age to claim them).
That's why it is so valuable for the higher-earning spouse to delay collecting Social Security as long as possible. It not only increases the worker's retirement benefit, but it locks in the maximum survivor benefit for the remaining spouse.
