Managing Social Security — and your lottery jackpot
Should one delay drawing Social Security? Should a lottery jackpot be taken in a lump sum?
Americans who make it to age 62 have a major financial decision to make: start drawing Social Security benefits now? Or wait?
On the other hand, very few of us will ever face the dilemma after winning a big lottery jackpot: take it as a lump sum or over 20 years?
The Business Journal asked a couple of wealth management professionals what they would recommend.
“Both questions have a lot of the same ingredients,” said Bob Prevette of Legacy Trust, a Grand Rapids firm. If a couple came to him with either question, he would have “a laundry list of things I would want to know about them before I could answer the questions.”
The Social Security question is a hot one right now, he added, because baby boomers are beginning to enter retirement — “and that is a huge chunk of the population.”
Chad Soukup, a senior advisor at Plante Moran Financial Advisors in Grand Rapids, said he is asked the Social Security question all the time. “Tell me exactly when you’re going to die and when your wife is going to die, and I’ll tell you exactly when to start collecting,” he said, half jokingly. “There is no one size fits all. It really depends on the retiree’s situation.”
People born from 1943 to 1954 reach full retirement age at 66. They can start drawing Social Security benefits at age 62, but the amount will be 25 percent less than if they wait until 66.
“You get an 8 percent per year increase” for each year you put off drawing Social Security, said Soukup, and you don’t have to start drawing until age 70. The incremental 8 percent is added for each year of delay up to age 70, which means the monthly amount you would receive at 62 increases by about 76 percent at age 70.
Soukup calculates a monthly benefit of $739 at age 62 would become a “full retirement” benefit of $1,000 if you start drawing at age 66, and about $1,320 at age 70.
Prevette noted that Social Security benefits are not taxed at 100 percent, “but if you have a lot of other taxable income on your tax return, that can push your tax on your Social Security higher, and that might affect your planning.” In other words, you might want to wait.
An individual drawing benefits before age 66 currently can earn $15,480 a year before it begins to reduce the payment, according to Prevette. For earnings more than that amount, “you lose a buck of Social Security for every $2 of earnings,” he explained. However, the earnings rule only applies before full retirement age. After that, what you are still earning won’t matter.
As for when to start drawing Social Security, Prevette said, “Usually it is better to delay if your circumstances permit. You build up more benefits.”
He said research surveys indicate “the vast preponderance of baby boomers have greatly under prepared for retirement, and they probably ought not to be retiring at 62 if they think they can live the kind of lifestyle they enjoyed, on Social Security alone.”
If a single person is collecting Social Security and dies, that person’s benefit ceases to exist. But if the individual is married, it’s a whole different story. “When you put a married couple together” in retirement planning, “there’s a lot of things to consider,” said Soukup.
Both Soukup and Prevette focused on the importance of the survivor benefit affecting married couples. Basically, that means if the spouse who had the higher income dies first, the surviving spouse can begin collecting the other’s higher benefit instead of their own smaller payment. The survivor may even start collecting at age 60 but at a reduced amount.
According to socialsecurity.gov, there are currently about 5 million widows and widowers receiving monthly Social Security benefits based on their deceased spouse’s earnings record. The government says that for many, those benefits keep them from poverty.
There are two ways to look at Social Security benefits: long term or monthly. If the goal is to collect as much as possible each month, then one should try to delay the benefit as long as possible. But if the goal is to receive the most money over the long term, then how long the individual is going to live is the deciding factor — and who can accurately predict that?
Prevette said an individual with his or her savings in IRAs and 401(k)s will have to pay tax on that money as it is withdrawn. That person may want to take Social Security benefits earlier because of the lower tax rate, to help defer withdrawing so much from the retirement accounts. He cautioned, however, that “you have to run the numbers far out to see the trend on an after-tax basis.”
When it comes to collecting a lottery jackpot, Soukup said there’s some certainty involved, so “it’s very much a math question in a lot of respects.”
Of course, taking it all at once means more of it will likely be eaten up by taxes than if it were taken over the 20 years or so the lottery allows for annuity payments. “And what are the terms of the annuity payout? That’s going to really help determine how the math works out in this decision,” said Soukup.
As a matter of fact, if you won a $1 million jackpot in the Michigan Lottery and opted for the lump sum payout, you wouldn’t get $1 million — only about half that, according to Jeff Holyfield, director of public relations for the Michigan Lottery.
“When they say the jackpot is ‘X’ amount, that’s the annuity basis,” explained Holyfield. Apparently, that’s the norm among state lotteries, which are “built on the idea it’s going to be paid out as an annuity.”
The Mega Millions jackpot this month was up to $400 million, but Holyfield said the actual lump sum payout was about $244 million “before tax.”
He said some financial planners would recommend taking the lump sum, paying the taxes, and investing what’s left for a better return than the annuity payments.
“That’s something for somebody to consider, but with that, you assume the risk,” said Holyfield, mentioning losses investors suffered in the stock market crash of 2008. “The annuity value — that’s guaranteed,” he added.
The lottery scenario, Prevette said, really hinges on the individual. People who have always been good money managers probably will hang on to lottery winnings longer than those who aren’t.
“People think of a million dollars as being a lot of money, but once you get the wrong pattern established, you can run through a million dollars in a heartbeat,” said Prevette, “especially if you are investing in depreciating assets” such as expensive homes, luxury vehicles, boats, RVs — all of which take more money to maintain.
“What I see happen in these scenarios is that people burn through their (lottery jackpots) in 10 years. With a lot of life left, they’ve spent everything they had and now they’re down to just Social Security and maybe a meager savings account,” said Prevette.
Holyfield said a Kent County resident, age 29, bought a Cash for Life instant lottery ticket that was worth $4,000 a week. But she asked for a lump sum payout, so the Lottery gave her $4.4 million. Otherwise, she would have received $208,000 a year for the rest of her life.
“She said, ‘I have things I want to do,’” said Holyfield.
One clarification about the word “life” in Cash for Life. The annuity payments are guaranteed for 20 years, meaning if the winner dies after 10 years, the winner’s estate will receive another 10 years of payments. Otherwise, the winner receives the annual payments as long as he or she lives.
For a lifetime Michigan Lottery prize, the state buys an annuity, the cost of which is determined by the annual prize payout and the age and life expectancy of the winner.