As many of you may already know, Social Security is complicated.
There are 2,728 Social Security rules and knowing when to file and how to file for Social Security can seem so overwhelming that many choose to ignore it and the planning opportunities this presents at their own peril.
There are Social Security strategies that you can implement to maximize your benefits regardless of your marital status (single, married, divorced, or a survivor), but the group that has the most opportunities available are married couples.
This is because there is often Dual Entitlement to benefits meaning that couples often have eligibility on their own Social Security record as well as on their spouse’s record.
One of the most critical things for couples to remember is that they need to coordinate their benefit claiming strategy with their spouse in order to maximize benefits as a couple.
In this article however, we’re going to focus more specifically on some planning opportunities and strategies for those that are self-employed as opposed to those that work for a company and receive a W2.
Being self-employed often means that you have more flexibility in determining how you receive your income between a mix of salary and/or profits from the company.
This is important when it comes to Social Security planning because of the way that your eventual Social Security benefit is calculated.
Basically, Social Security is set-up to be a progressive system meaning that the more income the you make and the higher your Social Security contributions, the less return you receive on each additional dollar you contribute.
This is due to what is called the Primary Insurance Amount formula.
The Primary Insurance Amount (PIA) formula is made up of three different bend points which are as follows:
(a) 90 percent of the first $885 of his/her average indexed monthly earnings, plus
(b) 32 percent of his/her average indexed monthly earnings over $885 and through $5,336, plus
(c) 15 percent of his/her average indexed monthly earnings over $5,336.
When applying the PIA formula, the Social Security Administration bases your eventual benefit on your highest 35 years of Social Security contributions.
Generally, to qualify for Social Security retirement benefits when you retire, you need to have collected 40 lifetime work credits.
You can earn a maximum of four credits per year, meaning you’ll have had to have worked at least 10 years during your lifetime to qualify based on your own work and earnings history.
Planning Opportunity #1: Because of the way the PIA formula is structured, this can present planning opportunities to those that are self-employed. It is true that the more you contribute to Social Security, the higher your eventual Social Security benefit will be.
However, you do have to ask yourself what those larger Social Security benefits are going to cost you to achieve them.
Based on the PIA formula above, someone with an average index monthly earnings figure over $5,336 is only going to be receiving credit at the rate of roughly 15 cents per dollar for each additional dollar of Social Security contributions.
As such, it can be helpful to plan what you are going to receive as a salary or wages and to keep this figure under $885 in average indexed monthly earnings or if that’s not feasible, at least between $885 and $5,336 in averaged indexed monthly earnings where you’ll still be getting credit at the rate of 32% vs. only the 15% if you exceed the monthly limit of $5,336.
The bottom line is that if you want to receive a higher level of credit for the money you contribute to Social Security, you are better off keeping your salary and wages low and receiving more of your income from the profits of the business. This can also be beneficial from a tax perspective but that is beyond the scope of this current article.
Planning Opportunity #2: For spouses that are self-employed and if both spouses work in the business, it is especially important to determine if any salary and wages subject to Social Security contributions should be split differently between the couple in order to maximize joint lifetime benefits for the couple.
It is important to note that splitting income differently purely for Social Security reasons is not allowed, however, for those that have legitimate business reasons such as an increase in work by one spouse for instance, this can present an opportunity to optimize future Social Security contributions for each spouse.
Over the years, this can be (and should be) adjusted in order to maintain the optimal level of contributions that will maximize their Social Security benefits.
As an example of this, take John and Mary. They’ve both contributed at the maximum level their entire careers to date but are now a couple and are in business together. Let’s take a look at how they could split $120k in possible salaries going forward:
- $120k to John/$0 to Mary = $1,244,502 in joint lifetime Social Security benefits
- $60k to John/$60k to Mary =$1,255,568 in joint lifetime Social Security benefits
- $109,200 to John/$10,800 to Mary = $1,339,726 in joint lifetime Social Security benefits
As shown in the example above, John and Mary can increase their Social Security by approximately $95,000 in lifetime benefits by planning how to split their income.
Planning Opportunity #3: When it comes to selling one’s business, some self-employed individuals sometimes work out an ongoing consulting or transition agreement with the new owners in order to receive a salary and this can also either help you increase your Social Security benefit or if you have not yet qualified for a benefit, this arrangement can help you reach the minimum of 10 years of work required.
Working and Receiving Social Security Under Your Full Retirement Age
If you are under your Full Retirement Age (66 for most people), you have to be careful about working while receiving a Social Security benefit. This is because of the Social Security Earnings Test and its especially problematic for those that are self-employed because there’s also an hourly work test.
First of all, the Earnings Test, as it’s called, applies to anyone under Full Retirement Age. The Earnings Limit for 2017 is $16,920 per year and this Earnings Limit is adjusted annually for inflation.
In the year that you reach your Full Retirement Age, but before your birthday that year, you have a bit more flexibility because the Earnings Limit increases to $44,880.
Once you have reached your Full Retirement Age, the Earnings Limit disappears entirely so you can earn as much money as you’re able to and not worry about the earnings test. So what happens when you work and you are receiving Social Security? Well, that’s when the Earnings Test can apply assuming you’re under your Full Retirement Age as mentioned.
Earning more than $16,920 in 2017 while collecting a Social Security benefit will cause the Social Security Administration to withhold $1 for every $2 in earnings over the Earnings Limit.
While this money is not technically lost (the Social Security Administration credits it to your account at your Full Retirement Age), claiming early and having benefits withheld can present two major problems:
1) Benefits will be withheld so you will not receive all the benefits (if any) anticipated as the result of claiming 2) Claiming early (even if you’re not receiving a benefit because it’s being withheld) will still lock you into the early claim date which means a suboptimal Social Security strategy and less money.
For the self-employed, in addition to the dollar limits mentioned above, there’s also an hourly limit. This is because the Social Security Administration recognizes that it would be too easy for many to shift income to stay under the Earnings Test.
Because of this, if you work for more than 45 hours per month as a self-employed person (even if you’re under the dollar limit) in most cases you will still be considered to be over the Earnings Test and subject to the same withholding rules.
Check Your Earnings History
You want to get credit for all your hard work, right? Well, make sure that you check your earnings record with the Social Security Administration on your Social Security statement.
It’s important because if there are errors in your earnings record, you won’t receive all of the Social Security benefits that you have earned. If there are errors, you have 3 years, 3 months, and 15 days to correct them. After that, it’s too late.
The Bottom Line
Making the optimal Social Security claiming decision and maximizing your benefits is complicated. You should work with a Social Security advisor that is an expert in the myriad of strategies that are available to you.
Determining which Social Security strategy is best for you and your family requires careful analysis as each situation is different.
If you have questions and would like to schedule a Free Initial Consultation with an advisor, you can do so by clicking here.
Talk with a Social Security Advisor and obtain expert advice that is customized to your unique circumstances.
Until next time,
Matthew Allen is the Co-Founder/CEO of Social Security Advisors and creator of the new course Maximizing Your Social Security produced in conjunction with Weiss Educational Services. Matthew has helped thousands of seniors maximize their Social Security benefits and avoid costly mistakes when filing. Matthew has been at the forefront of financial services for over a decade. In addition to co-founding Social Security Advisors, Matthew also founded The Universal Group of Companies, a private investment firm, in 2004. From 2000 to 2004, Matthew was a NYSE Market Maker with LaBranche & Co., a Fortune 500 New York Stock Exchange firm.