Social Security and Medicare Planning

By Melinda Kibler Sep 15, 2014, 12:13 PM 

Many Americans think that Social Security and Medicare are one-size-fits-all programs that offer no opportunity for choice or customization. But in fact, taking the time to fully understand how these programs work and to consider the most effective ways to include them in a long-term financial plan can significantly expand their usefulness.

A common misconception about Social Security is that workers’ taxes are held in personal accounts for the use of the workers who earned them. In fact, the taxes that today’s workers pay into Social Security support the benefits of today’s retirees, as well as other Social Security recipients such as disabled workers, survivors of workers who have died and dependents of beneficiaries.

When you work and pay Social Security taxes, you earn credits toward your future benefits. The number of credits you need to secure retirement benefits from Social Security depends on your birth year. As of 2014, workers receive one credit for each $1,200 they earn, up to a maximum of four credits per year. Assuming you were born after 1929, you will need 40 credits, the equivalent of 10 years of work, to earn retirement benefits.

How much you work also affects the amount of your eventual benefit payments. Higher lifetime earnings result in higher benefits later on. If there are years you do not work or earn very little, you may receive a smaller benefit amount than you would have if you’d worked steadily throughout your career. The age at which you begin collecting benefits can also affect the size of your benefit payments; I will discuss this more fully later in this article.

Medicare is also funded by payroll taxes, in addition to monthly premiums from those taking advantage of the program. Medicare is a health insurance program mainly for people age 65 and older, though certain younger people with specific disabilities can also qualify. The program helps with health care costs, though it does not cover all medical expenses or the cost of most kinds of long-term care. Medicare comes in four parts:

  • Part A helps pay for inpatient care at hospitals or skilled nursing facilities following a hospital stay, as well as some forms of home health care or hospice care.
  • Part B is basic medical insurance, which helps pay for services from doctors, outpatient care, home health care, durable medical equipment and certain preventative services.
  • Part C is also known as “Medicare Advantage;” these plans are available from private companies in certain areas. People with Medicare Parts A and B can choose to receive all of their health care services through a Part C provider organization. These plans combine coverage for hospital stays and doctor visits.
  • Part D helps cover the cost of prescription medication.

Many people expect to take advantage of Social Security, Medicare or both one day. Taking time to integrate these programs into your overall financial plan can help you to secure the greatest benefits available.

Social Security Planning

A common question about Social Security is when to start drawing benefits. You can start drawing benefits as early as age 62 but, as mentioned earlier in this article, drawing your benefit as soon as you can will reduce your benefit amount. Your benefit will be larger if you wait until full retirement age (FRA). Your FRA is determined by your birth year; for anyone born in 1960 or later, it is 67. If you take your benefit as soon as you turn 62, your benefit payment may be between 20 and 30 percent less than it would have been if you had waited until you reached your FRA.

For some, this tradeoff may be worthwhile. On the other hand, it is worth noting that your FRA is not a cutoff for earning Social Security credits. If you work past your FRA, you can add up to four credits a year until you eventually retire, and higher lifetime earnings ultimately mean higher benefit payments, since Social Security takes the average of your 35 highest earning years to calculate your benefit. Additionally, your benefit automatically increases each year that you wait from the time you reach FRA until you start receiving your benefit or reach age 70, whichever happens first. For many, the benefit can increase approximately 8 percent for each year you delay benefits after your FRA.

You can also receive benefits while you continue to work. However, your benefits will be reduced if your earnings exceed certain limits in the months leading up to your full retirement age, so it is important to be mindful of the timing of your work income. If you start receiving benefits before your FRA but continue to work, $1 in benefits will be deducted for each $2 in earnings over the limit; in the year you reach your FRA, this amount changes to $1 for every $3 you earn over a higher annual limit, until the month of your FRA.

Because of this rule, if you have started benefits while not working but need to return to work before your FRA, you might want to pause your benefit payments. You might also want to pause payments if you realized you should not have claimed as early as you did. Unfortunately, you cannot stop your Social Security payments unless it has been 12 months or less since you began drawing benefits or you have already reached FRA. If you do not meet either of these conditions, you cannot pause your benefits until you reach your FRA, so be cautious when deciding when to claim your benefit.

You may sometimes hear about an older “pay back” strategy. Formerly, you could effectively use your Social Security benefits as an interest-free loan. You could collect benefits early, pay them back and restart your benefit at a higher rate as you approached or reached your FRA. However, as of December 2010, the government imposed the 12-month limit on stopping benefits, greatly reducing Social Security’s use as a loan mechanism.

Sometimes a married couple will decide that filing and suspending is the best strategy. For this to work, the person suspending must have reached his or her FRA. The strategy can allow the lower earning partner to collect a spousal benefit, for a total benefit payment up to 50 percent of the higher earning partner’s benefit, while the higher income spouse suspends benefits, accumulating delayed retirement credits. For example, John and Sue have both reached FRA. John is eligible to receive $2,400 monthly from Social Security; Sue will only receive $600. To use a file and suspend strategy, John files first, allowing Sue to collect $1,200 total between her own benefit and her spousal benefit. Once Sue files, John suspends his application. Sue can still receive the $1,200 every month, even though John has stopped collecting his checks. At age 70, when he no longer receives increased credit for delaying, John will reactivate his benefits.

For couples who need extra income, but who don’t want to start Social Security all at once, the option of a restricted application might be helpful. In this strategy, one partner files for full benefits, while the other simply uses the spousal benefit to piggyback off the spouse’s income. When the person receiving the spousal benefits reaches age 70, he or she can switch to a full benefit based on his or her own lifetime earnings. This technique provides a higher survivor benefit for the spouse who filed first, since the spouse who waited increased his or her benefit amount by doing so. Note, though, that this strategy only works if the partner applying for the spousal benefit has reached his or her FRA. Otherwise, he or she is assumed to be filing for their individual benefit in addition to the spousal benefit, and the individual benefit is consequently locked in at a lower rate, defeating the strategy’s purpose.

As you can see, while Social Security benefits are mainly designed to benefit the worker who earned them, married couples receive special consideration. Even if your spouse has never worked, he or she can receive a spousal benefit up to one-half of your benefit amount. If both partners have worked, personal benefits are always paid before spousal benefits unless you employ one of the previously discussed strategies. Claiming a spousal benefit does not reduce the main earner’s benefit amount.

Divorced spouses are often eligible for spousal benefits too, even if the divorced worker has remarried. If your ex-spouse remains unmarried and your marriage lasted 10 years or more, he or she is entitled to benefits as long as he or she is age 62 or older and the spousal benefit is greater than the benefit he or she would receive based on personal work history.

Survivors may be able to receive benefits if an individual who worked long enough to qualify for Social Security benefits dies. Survivors who may be eligible include:

  • Widowed spouses age 60 or older, or age 50 or older if they are disabled;
  • Widowed spouse of any age who care for the deceased’s child, if the child is under 16 or disabled;
  • Unmarried children who are under 18 (or up to 19 if they are students in elementary or secondary schools) or who have a disability that began prior to age 22;
  • Stepchildren, grandchildren, stepgrandchildren or adopted children, under certain circumstances;
  • Surviving divorced spouses who meet the criteria discussed above.

I have mentioned disability several times in connection with Social Security eligibility. In general, two different earnings tests together determine whether an individual is eligible for disability benefits. First, a “recent work” test is based on the individual’s age at the time he or she became disabled. Second, a “duration of work” test must show that the individual worked long enough to be eligible for the benefits. If you qualify for disability benefits but are later able to return to work, Social Security disability benefits continue until you complete a trial work period, in which you earn more than $770 per month for nine months within a 60-month period. After the trial period, you can still work and receive benefits for any month your earnings are not “substantial.” In 2014, this is defined as over $1,070 for the month. This extended period of eligibility lasts for 36 months.

Social Security benefit payments may be partially subject to tax, no matter the circumstances under which you draw them. How much of the benefit is taxable will depend on your total income and your marital status. For married couples filing jointly, if your combined income is over $32,000, between 50 and 85 percent of benefits will be taxable; for individuals, this threshold if $25,000. Whatever portion is taxable will be taxed at ordinary income rates. Since U.S. citizens are taxed on worldwide income, these rules apply no matter where you live. If you do live abroad, your ability to receive benefits (and your potential to be taxed on them) will generally not be affected. There are a few countries where Social Security payments cannot be sent, however, so be sure to be aware of these restrictions before relocating or planning extensive travel.

Medicare Planning

If you have already received Social Security benefits, the federal agency that runs Medicare will contact you a few months before you become eligible regarding enrollment. Otherwise, you should sign up three months before you turn 65, even if you are not retired and have no plans to retire in the immediate future. There are also certain special cases in which you can apply prior to age 65. These include government employees who become disabled before age 65 or anyone with permanent kidney failure. Once you are enrolled, you will receive a Medicare card that indicates which parts cover you.

When you first become eligible for Part A, you have a seven-month period, referred to as the initial enrollment period, in which to sign up for Part B. If you delay signing up, you will ultimately end up with delayed coverage and higher premiums. You will, however, have a chance to sign up in the general enrollment period each year, which runs from January 1 to March 31. Your Part B coverage begins on July 1 of the year you enroll.

Given the potential for higher costs, why would you not enroll right away? The most common reason is that you already have medical insurance you plan to keep. While hospital insurance (Part A) is free for almost everyone, medical insurance (Part B) comes with a monthly premium. You need to weigh whether the additional coverage is worth the extra monthly cost. There is no one right answer to this question; it will depend on your personal situation and the sort of insurance you already have. Speak with an insurance agent to see how your private plan and Medicare Part B fit together. This is especially important for those covered under a family policy. It is also important to note that neither private health insurance policies nor Medicare typically covers nursing home or long-term care. These needs should be planned for separately. For those who choose to delay enrolling in Part B, a special enrollment period is available to those with employer plans. The special enrollment period allows you to enroll in Part B any time while you are still covered by the group health plan, and up through eight months after the employment or group coverage ends (whichever comes first), without penalty.

Should you choose to enroll in both Medicare Part A and Part B, you are eligible to purchase Medigap, which is a Medicare supplement policy. Medigap is private insurance that helps pay some of the health care costs Medicare doesn’t cover, such as copayments and deductibles. Medigap is different from a Medicare Advantage Plan (Part C) and cannot be used if you have Part C coverage. Medicare Advantage Plans are a way to get Medicare Part A and B benefits through private insurance, while Medigap supplements the costs of your original Part A and B benefits through Medicare. There are 14 Medigap policy options, named A through N. (Plan A offers the least coverage; Plan N offers the most.)

Medigap providers are generally allowed to use medical underwriting to decide whether to accept your application and how much to charge you for your policy. However, there is a Medigap Open Enrollment period, during which you can buy any policy the company offers for the price available to someone in good health, even if you have health problems. If you apply at any other time, there is no guarantee that you will be able to secure a Medigap policy or that it will not be prohibitively expensive.

What about Medicaid? While Medicaid and Medicare are often mentioned together, these are separate programs. Medicaid is income-based, not age-based, and it is administered by the states. Each state’s rules about who is eligible and what is covered are different. If you suspect that you may qualify for both Medicare and Medicaid, it is important to make sure you understand what each program covers and what it does not.

Both Social Security and Medicare can introduce a host of additional financial planning issues beyond the scope of this article. By keeping the basics in mind, however, you can start integrating these programs into a balanced, big-picture view of your financial plan for the latter part of your working life and ultimate retirement.

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