Social Security Shock: Backroom Budget Deal Bans Two Loopholes

Two weeks ago, “things that go bump in the night” included two Social Security claiming strategies that got bumped from most retirement planning when the Senate passed a last-minute budget deal in the predawn hours of Friday, Oct. 30. There were none of the usual preliminaries: no hearings, no legislation, no grandstanding by proponents and opponents, no discussion in the financial media. It was simply a done deal, sealed and delivered, when President Barack Obama signed the bill into law last Monday to keep the government afloat. Now, however, there’s plenty of discussion, along with plenty of shell-shocked seniors and financial advisors. Here’s why.

Unintended consequences

The Senior Citizens Freedom to Work Act, passed in 2000, was intended to avoid penalizing people for working longer. The act created “voluntary suspension,” which enabled people who had already begun claiming Social Security to stop benefit payments and accrue delayed retirement credits. The two voluntary suspension claiming strategies created by the act are:

  • “File and suspend,” which enables a spouse to file for spousal Social Security benefits before the worker is ready to claim his or her own benefit. The net effect of this strategy is allowing couples to enhance the value of their benefits.
  • “Restricted application for spousal benefits,” which enables a higher-earning spouse to receive just the spousal benefit from a low-earning spouse while his or her own benefit builds delayed credits. Likewise, this strategy ultimately results in a higher benefit.

But as often happens when well-intended tinkering alters part of a complex system, there were unintended consequences — in this case, loopholes that have recently become standard recommendations for financial advisors transitioning clients into retirement.

Loopholes for the wealthy?

While the strategies were totally legal and allowable under the Social Security rules, critics branded them “loopholes for the wealthy” that cost the Social Security system— already underfunded and facing a deficit — money it could ill afford.

If everyone who is eligible took advantage of these two strategies, the Center for Retirement Research estimated in 2009 that the cash-strapped Social Security Administration could be on the hook for as much as $10.5 billion in additional benefits — and potentially much more as the silver tsunami of baby boomers, many of whom are two-earner couples, begins retiring and claiming benefits.1

What changes?

As part of last week’s stealth budget deal, these two Social Security loopholes have been closed. Moreover, the changes go into effect quickly.

  • The file-and-suspend strategy ends on approximately May 1, 2016, 180 days after the bill’s enactment. The former rules will continue to apply only for those already 66 years old and those who will turn 66 within six months of the new law’s enactment. For everyone else, no spousal benefits — or other dependent benefits — can be paid from a suspended benefit.
  • Regarding filing a restricted application, anyone who turns 62 after Dec. 31, 2015, will lose this right. That means that a person entitled to both his or her own retirement benefit and a spousal benefit will be paid the larger of the two. In other words, if that individual’s retirement benefit is larger than the spousal benefit, there will be no entitlement to the spousal benefit.

What else changes? An untold number of retirement income plans already put in place to take advantage of these strategies. Advisors will have to scramble to rework many of their clients’ planned approaches to retirement to make up for the loss of anticipated income.

1 Source: Center for Retirement Research, “Unusual Social Security Claiming Strategies: Costs and Distribution Effects,” Alicia H. Munnell, August 2009

Important information

The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.

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