Social Security calculations involve a number of variables that are affected by your clients’ financial health, their retirement age, and other income sources they plan to have during retirement. As financial circumstances change over time, Social Security income projections need to be amended to account for  their expected future earnings.

Given the different variables at play, advisors should take a proactive role in educating clients on how financial planning decisions affect not only the amount of Social Security income they receive, but also the timeline for claiming those benefits—as well as the tax costs associated with various decisions.

Here are three things to keep in mind when calculating Social Security benefits for clients based on their evolving retirement plans.

1. Delaying Social Security benefits isn’t always the best decision.

For most clients, delayed Social Security benefits offer the best long-term financial reward because they offer the largest overall payment. The Social Security Administration offers a schedule outlining the percentage of Social Security benefits a person is eligible to receive based on when they start receiving benefits. 

If your client (born between 1943 and 1954) starts receiving benefits at 66 years of age, for example, they’re entitled to 100 percent of their Social Security benefits. Delay those benefits until age 70, though, and they can receive 132 percent—a significant increase in monthly earnings.

Although this makes sense for a lot of retired individuals and couples, delaying may not be a practical option for some of your clients. If a client is younger than 70 and doesn’t have another significant source of finances, it’s unrealistic—and unwise—to delay those benefits. And even if your client does have the financial means to keep delaying Social Security benefits, doing so might not offer the best overall return compared to other wealth management strategies.

Some clients, for example, may prefer to claim benefits early and invest them into strategies that offer a greater potential return. Consider the following scenario: At 66 years of age, your client claims their Social Security benefits and starts placing all of that money into an investment fund that averages an 8 percent annual return on investment. 

By claiming at 66, they’re sacrificing the additional 32 percent of Social Security benefits that they could have received by waiting until age 70 to claim their benefits. But through an investment fund that offers an 8 percent return, those initial funds invested at age 66 are now worth more than 136 percent of their initial value. In this scenario, their investment strategy offers a 4 percent gain in value over what your client would have earned through delaying their benefits.

Obviously, this approach courts an added degree of risk. As an advisor, it’s your job to present these options to your client so that they can make a decision they’re comfortable with. Some may prefer to claim these benefits early and use them to continue growing their wealth. Others may feel more comfortable waiting and claiming the guaranteed benefits later.

2. Additional income can lead to taxation on Social Security benefits

Social Security benefits likely aren’t the only income source your clients will be leaning on in retirement. It’s important to remember that other sources of income will likely result in the taxation of some of your clients’ Social Security benefits.

The calculation of taxable income is relatively complex. Social Security benefits may be taxed whenever your clients’ total income exceeds $25,000 for an individual or $32,000 for married couples filing jointly. The highest-earning individuals and couples have to pay taxes on up to 85 percent of their Social Security benefits.

When calculating Social Security and other sources of income, taxation is a crucial consideration. Some clients, for example, may prefer to delay their benefits until later in retirement, and in the meantime lean on other sources of income that would be taxed anyway. Alternatively, financial advisors may recommend pairing Social Security benefits with Roth IRA withdrawals, which aren’t counted as income for tax purposes. A married couple withdrawing from a Roth IRA could also earn up to $32,000 in Social Security benefits and still pay no taxes on this income, regardless of how much is distributed from the Roth IRA during that year.

Ideally, financial advisors should be able to guide clients toward wealth management strategies that minimize their tax obligations over time, preserving more of their wealth. Advisors should be able to explain these tax implications by walking clients through various scenarios based on their potential earning opportunities, as well as possible strategies for withdrawing from IRAs. The amount of taxation for each scenario may determine their preferred strategy for funding their retirement.

3. Certain financial situations can have crucial implications for your clients.

In some cases, your clients may have complicating factors that need to be accounted for when calculating Social Security income. Or they may simply not understand the many different factors that can affect the amount of their earnings.

Divorce is one such example. Many of your divorced clients may be eligible to collect benefits from one of their ex-spouses. Or the opposite may be true: A portion of your client’s Social Security funds may be owed to their ex-spouse, unless that individual remarries. In general, if your client was married to someone for 10 years and never remarried, your client  can claim half of their ex-spouse’s full Social Security retirement benefit. This needs to be accounted for in your retirement planning.

Other factors to consider include:

  • Average earned income. Social Security benefits are calculated according to your 35 highest documented earning years. For some clients, delayed retirement can help eliminate some of the lowest-earning years from this calculation, which can increase their Social Security benefit.
  • Employment plans during retirement. If a client wants to continue working after they start claiming their benefits, they may actually pay fewer taxes—and earn more Social Security income—by opting to delay their earnings. In some cases, they may also prefer to cap their annual earnings to minimize any reduction to their Social Security benefits.
  • General client health. Health considerations are a crucial part of retirement planning, and your clients may not be accounting for these needs. A troubled family health history or existing health problems among the members of a family could prompt clients to claim Social Security benefits earlier than they had originally planned. 
    • Consider talking through this type of scenario to demonstrate how a sudden change to retirement planning affects their overall financial outlook. Ultimately, your clients need to feel comfortable with their Social Security benefits plan, while accounting for a range of different possibilities.

Less common factors, such as self-employment, the Government Pension Offset, and the Windfall Elimination Provision, may affect Social Security benefits. Make sure clients understand these implications as they plan their retirement.

Don’t wait until retirement to address Social Security.

Social Security plays a critical role in most of your clients’ retirement plans. Even if retirement is years away for your clients, it’s still helpful to explain what they can expect in terms of Social Security benefits and the potential tax implications of other financial decisions related to retirement income.

Although the future is always uncertain, scenario planning, and regular communication with your clients can help you create a retirement strategy that is flexible and supportive of your clients’ top financial goals. 

Ready to discover more insights into recent retirement planning trends? Download our latest guide, Inside the SECURE Act: For Financial Advisors and Your Clients.

Download “Inside the SECURE Act: For Financial Advisors and Your Clients”