Image: Social security checks
Bradley C Bower  /  AP file
“There’s a view that Social Security is a simple system. But it’s actually very complex,’” says David P. Richardson, a principal research fellow at the TIAA-CREF Institute. And, he notes, the cost of making the wrong decision can be large.
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updated 2/24/2011 7:38:32 AM ET 2011-02-24T12:38:32

When should you apply for Social Security? It’s a simple question with no simple answer. In fact, coming up with the perfect answer requires you to be part actuary, part financial planner and part fortune teller. Still, you can make a better decision if you take the time to understand some of the twists in how benefits are calculated.

Before we venture down that winding road a warning for the oldest baby boomers, who turn 65 this year: Regardless of when you take Social Security and when you stop working, you need to enroll in Medicare when you first become eligible at 65, or you could face financial penalties in the form of higher premiums. (You can start the sign-up process here up to three months before the month of your 65th birthday.)

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By contrast, you can start collecting Social Security anytime from age 62 to 70 and the later you start, the bigger your benefit. Just how much bigger depends on when you were born. Americans born from 1943 to 1954 have a “normal” or “full” retirement age of 66. They get 25 percent less than their normal benefit if they cash in at 62 and 32 percent more than their normal benefit if they wait until 70. (Those born in later years have a slightly higher “normal” retirement age which means they take a somewhat bigger hit for claiming their benefits early and get somewhat less of a bonus for waiting until 70.)

Say you are turning 62 this June and earn $50,000 a year. You could collect about $988 a month at 62 years, or $1,391 a month (in today’s dollars) at your full retirement age of 66 in 2015, or $1,934 a month (again in today dollars) starting in 70 in 2019. If you’re earning $150,000, the comparable monthly amounts would be $1,760 at 62, $2,388 at 66, and $3,209 at 70. (You can estimate your benefits here.)

While those benefit amounts sound dramatically different, in theory the system is actuarially neutral — meaning if you live to an average age, you’ll end up with roughly the same total benefit no matter when you claim. But that’s not really the case. The most obvious example of this: women live longer, but benefits aren’t adjusted by sex. So women are more likely to live past the “break-even age” — that is, the age at which waiting to collect a bigger check pays off.

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Here are some points to consider when making your decision:

If you’re still working, don’t claim benefits before your full retirement age.
After studying at length when folks should claim their benefits, David P. Richardson, a principal research fellow at the TIAA-CREF Institute, concludes “it’s a very idiosyncratic, very difficult decision” and that there is only one generally applicable rule of thumb. Says he: “Never claim early while working unless you really need the money to survive.” That’s because of the earnings penalty. Until you reach the full retirement age, for each $2 you earn above $14,160, you lose $1 of your annual Social Security benefits. After 66, benefits don’t get cut no matter how much you earn. (If you reach 66 in 2011 you can earn $37,680 in the months before you reach 66, without affecting your benefits. For each $3 you earn above that, you will lose $1 in benefits.) Note that if you take early benefits and then earn too much, your check will be increased some at your full retirement age to take account of what you lost. But when all the different adjustments and taxes are considered, Richardson says, it just doesn’t pay to take benefits while you’re still earning a decent salary.

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Don’t take Social Security until you’re sure you want it.
In December, the Social Security Administration effectively killed a “do-over” strategy that had allowed seniors to file for benefits and then later repay them, without interest, and get a bigger check. In effect, you got eight years—from 62 to 70– to change your mind about taking early benefits. You could even use a do-over as a way to get an interest free loan from the government. But since the December change, you have only 12 months to change your mind after initially filing for benefits. (More on this development, as well as how it affects those who are already retired, is here.)

Consider your family genes and general health.
If you don’t need an early check to make ends meet, and particularly if you’re single, this could be a significant factor in your decision. A calculator on the Social Security site will give you average life expectancy, without regard to your health or family history. It shows a woman turning 62 next month will live to an average of 85.1 and a man to 82.6. But when TIAA-CREF sells annuities —and people who buy annuities tend to live longer — it assumes a 62 year old woman will live to 89.4 and a man to 86.6. Play around: Numerous sites on the web will calculate your life expectancy taking into account your health, family history, exercise, eating, drinking and driving habits and even social relationships. If you’re in poor health, and you want to get some of your tax dollars back, it can make sense to claim Social Security as early as possible.

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Don’t get hung up on the break-even date.
You’ll hear a lot of talk about the “break-even” age — the age you have to live to so that waiting to collect a bigger check pays off. But be aware that this age depends on the discount rate you apply when valuing future benefits. (The higher the discount rate, the longer it takes for you to break even by deferring benefits. For example, Richardson calculates, using a 2 percent real discount rate, waiting until 66, instead of taking benefits at 62, pays off if you live until around 80; using a 4 percent rate you must live until 84.)

Moreover, just looking at the break-even age understates the price you pay for claiming benefits early, particularly if you’ve got hardy genes, experts say. Anthony Webb, of the Center For Retirement Research at Boston College, argues that by waiting to claim a bigger check you’re buying “longevity insurance” — that is insurance against outliving your money. Put another way, by waiting, you’re buying a larger inflation adjusted lifetime annuity for a lot less than you could buy a commercial annuity, even from a low cost, no-commission provider. “This is the first port of call for buying an annuity,’’ says Webb.

Understand the couples game.
Here’s where claiming strategies can get really complicated — and where understanding the Social Security rules is even more important. Remember that supposed actuarial equivalence of early and delayed benefits? It doesn’t take into account the favorable way Social Security treats married couples. If one partner dies, the survivor can claim the deceased spouse’s check instead of his or her own, assuming the dead spouse’s check is bigger. This is crucial because of something known in the actuarial and insurance businesses as joint mortality: With two individuals, there’s a greater chance that at least one of them will live to a ripe old age and collect that bigger check. The upshot: At least one partner (usually the higher earning one) should delay benefits well past 66, to buy that higher lifetime “second-to-die” annuity for both of them.

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Then there’s the issue of how spousal benefits are calculated when both partners are still alive. When you claim benefits, you’re eligible for what you yourself have earned, or up to half of your living spouse’s full retirement benefit, whichever is higher. A low earning spouse who is relying on spousal benefits takes an even bigger early claiming hit than a primary wage earner–if she claims benefits at 62, she gets just 35 percent of the primary earner’s full retirement age check, instead of 50 percent. On the other hand, she gets no extra benefits for waiting past full retirement age to claim her check. So, for example, if a husband is four years older, a one-income couple would receive the maximum benefit if the husband claimed at 70 and the wife put in for her spousal benefits at 66.

But there’s yet another angle. Suppose a couple wants at least some cash coming in from Social Security before the hubby reaches 70? Once he reaches his full retirement age of 66, he can claim his benefits and then ask that his claim and his benefits be immediately suspended. He then can continue to wait for a bigger benefit, while his wife is now eligible to claim spousal benefits. (For more on this strategy, read the Center For Retirement Research paper here. )

And there’s this: Once you reach full retirement age, you can choose to take benefits as a spouse, while deferring your own earned benefit until later. So in a two-income marriage where the partners are the same age, one might claim benefits at 66. The other could then claim 50 percent of those benefits as a spouse, while allowing his or her earned benefit to build until 70, buying longevity insurance for both of them.

“There’s a view that Social Security is a simple system. But it’s actually very complex,’” says Richardson. And, he notes, the cost of making the wrong decision can be large.

For more advice, see the Center For Retirement Research’s Social Security Claiming Guide here.

© 2012 Forbes.com

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