Avoiding Costly Mistakes When Claiming Social Security with Ken Sokol

Social Security Surprises and Mistakes

[00:04:26] Dean Barber: As you started looking at Social Security, you started getting a few surprises. There were some things that you weren’t aware of. And if you weren’t aware of them, probably a lot of people weren’t aware of them. So, let’s start talking about some of the things that you started seeing with Social Security that started to surprise you.

[00:04:42] Ken Sokol: You can start Social Security anytime between 62 and 70. Well, I was 54, almost 55, in retirement, so it was a long way off. So, when do you start it? There’s any month between 62 and 70. I found out that there are some spousal benefits to this. My wife had worked part-time in nursing and she was fully retired, but there were some spousal benefits. There were survivor benefits. I couldn’t figure out how to make all these calculations, so I asked to see a Social Security rep. I had my chart and I said to him, “Fill in my chart, please.”

[00:05:26] Dean Barber: What did you see when he filled in that chart? You also found the delayed credits, the cost of living increases that start at age 62. Any time you’re in that delayed status, people don’t realize that they started getting the cost of living increases. They don’t understand how exponential that increase can be from age 66 to age 70 or from today we call it full retirement age to age 70. So, talk a little bit about those things.

Don’t Think Social Security Isn’t Taxable

[00:05:51] Ken Sokol: The benefit at 62 is literally almost half of what it might be if you delayed until 70. But there was also this other thing that said, “Well, wait a minute.” In 1984 under the Reagan administration, there was this thing called tax on Social Security. Well, how did that come into play? And then under Clinton in 1993. There are two steps to making part of Social Security taxable.

So, there was this factor and I said, “I’d like to have more money that’s not fully taxable…” All these things played into account. It became very complex with all these calculations. It wasn’t for the faint of heart, but it was something. So, I spent a lot of time crunching numbers. How do I display this? What do I do to understand this? How does it affect me, et cetera? I had a lot of time on my hands in that early retirement years.

[00:06:58] Dean Barber: In addition to diving into Social Security, you also started preparing tax returns for AARP. Suddenly, you find this marriage between Social Security and taxation and this whole way that Social Security is taxed. There’s a different formula that people need to understand before they start claiming Social Security because you can actually start to cause a dollar of distribution from an IRA can also cause a dollar of Social Security to become taxable.

A Tax Mistake Sends Ken Down a Social Security Rabbit Hole

Even if you’re in a 22% bracket in today’s world, you could be causing 44% tax on just a dollar distribution out of an IRA. You need to be aware of those things. You can make the right decision with Social Security, but if you don’t understand the tax implications of it and how it fits into the rest of your overall income strategy, you can lose a major portion of that to Uncle Sam.

[00:07:56] Ken Sokol: Your numbers are right on. It started with me with a client that I told, “Here’s the estimated tax you should pay.” She came back the following year and her income went up $5,000 and her taxes went up $2,000, a 40% marginal tax. I made a mistake.

[00:08:18] Dean Barber: Because at that point, there was no 40% marginal rate.

[00:08:20] Ken Sokol: Yeah. I went back and crunched the numbers and said, “What is going on?” I had to bring the client back and say, “Well, the tax program did the correct numbers, but the taxing of Social Security is something I’m not familiar with.” My research led me to Scott Burns’ article on a tax torpedo. And so, I’m starting to go, “Hey, I’ve got to figure this critter out.”

How Social Security Is Taxed and Why It’s Easy to Make Mistakes When Claiming

[00:08:53] Dean Barber: Right. What you’re talking about is what is referred to in the tax world as the provisional income limits, right?

[00:08:58] Ken Sokol: Correct.

[00:09:00] Dean Barber: Just for people that aren’t familiar with those, those provisional income limits for a married couple, I believe the number is, I guess, $32,000 for a married couple, that up to 50% and then…

[00:09:11] Ken Sokol: $32,000

[00:09:12] Dean Barber: $32,000 and then $44,000, right?

[00:09:14] Ken Sokol: $44,000.

[00:09:15] Dean Barber: If your provisional income eclipses $44,000, then up to 85% of your Social Security can become taxable. That provisional income is made up of all taxable sources of income, plus 50% of your Social Security, plus any interest from tax-exempt bonds. What it doesn’t include, which I think is the beautiful thing, is any distributions from a Roth IRA that does not get included in that provisional income. You could have as much Roth income as you want, and it doesn’t cause any of your Social Security to become taxable.

Calculating When to Claim Social Security and How It’s Taxed

[00:09:44] Ken Sokol: Exactly. The distribution management can have a dramatic impact on your income, your net income after taxes. These calculations aren’t for the faint of heart. They’re not something that an average individual is going to be aware of.

[00:10:05] Dean Barber: I don’t think they understand the magnitude of dollars that are at stake here. I always tell people when you’re talking about the whole financial planning process, people are so focused on the investment return or what’s going on in the economy. Those are things that are out of our control. But managing your distributions and properly claiming your Social Security strategies, those are well within your control. You made a comment to me earlier on of how many different iterations there are that a person could come with their Social Security and what’s the difference between the best and the worst? What did you find there?

[00:10:39] Ken Sokol: An individual can start at 62 or any month in between up to age 70 and their spouse can do the same thing. And then you say, “Well, what’s the prevailing cost of living adjustment? What is the tax provisions, etc.?” We found out there can be a trillion iterations for a couple as far as all these claiming strategies and some of them have eliminated the ability to withdraw and suspend benefits, etc.

But all these come into play. And again, to get through all these minutiae and find out what it means for an individual, the chart that we’re talking about and looking at marginal tax actually changes, morphs, depending on the amount of Social Security that you have. So, it’s not one chart that’s the same for everybody. It’s almost that each individual has their own chart.

Social Security Is Like a Fingerprint, Unique to You

[00:11:38] Dean Barber: It’s almost like your fingerprint. It’s unique to you.

[00:11:42] Ken Sokol: Exactly.

[00:11:43] Dean Barber: I think people want to say, “Let me just read a book about this and I’ll figure it out myself,” or, “Isn’t there just a rule of thumb or something?” And there’s absolutely not. It is a very complex calculation that could make a difference of maybe $100,000, $150,000, $200,000 of additional spendable money just by how you claim your Social Security and how you do the distribution planning.

[00:12:05] Ken Sokol: Exactly. I could give you some examples and go on to some but some of them are very dramatic. Life expectancy is probably the most important criteria in this calculation of what’s better. I’ve traveled around the country lecturing to planners and one of the things that I get to discuss is life expectancy. For many of us that have worked for good companies like Hallmark Cards for their career, you have had medical insurance and take care of yourself. I think the baby boomers are going to blow away the life expectancy tables.

Baby Boomers Life Expectancy and Social Security Solvency

[00:12:42] Dean Barber: There’s no question. They’re already living longer, already more health-conscious, and they’re doing things that their parents didn’t do to stay healthy and be more vibrant at an older age. Let’s talk about life expectancy for a minute because I think this is a big mistake that gets made when people are trying to decide what they should do with their Social Security. They’re thinking about their own personal life expectancy. They’re not thinking about the survivor.

A lot of the Social Security claiming strategy should go under the assumption that one or of the individuals is going to live beyond what is considered normal life expectancy today and how you claim the spousal benefits, et cetera. And when one person claims versus another will impact that surviving spouse in a big way.

[00:13:31] Ken Sokol: Let me throw out one statistic that I’ve come across. At age 65, there’s a 50% probability that one of a married couple, one of the partners will live to 90. The concern for a lot of people is am I going to outlive my money, my resources? If you stop and think that of a couple at age 65 that one of them will live to 90, you need to be prepared.

Social Security Spousal Benefits Need Consideration

[00:14:04] Dean Barber: The other piece of it that I’m going to come back to is the tax side of it. If you’re a married couple and then suddenly one spouse is gone, you’re now a single filer. And it’s almost like a penalty to be a single filer, that married couple, the income’s not going to change dramatically when one spouse passes away unless somebody has a large pension and they choose a single life only. So, likely that income remains fairly close to what it was before but the tax burden almost doubles.

[00:14:35] Ken Sokol: Yes. I see this every year with widows that come to have their taxes prepared and there’s not much leniency from the tax structure. You work with a different threshold for taxing Social Security, but I see more people getting into that situation and they have fewer options. It is horrendous that marginal tax when it occurs can be at 44%. Hopefully, one of the recommendations that I would have for Social Security is to index those thresholds so that pushing that point at which Social Security benefits become taxable. Today, an individual or a married couple with Social Security as their only source of income, there is no federal or state tax.

Again, Social Security Is Taxable

[00:15:30] Dean Barber: Correct. Social Security by itself is a tax-free asset.

[00:15:33] Ken Sokol: Correct. In 10 to 15 years, Social Security as a sole source of income will start to become taxable unless they index those thresholds to move them out and adjust them every year with the cost.

How, Why, and When Social Security Became Taxable

[00:15:49] Dean Barber: Yeah. So, you made the point earlier. I think it was a Tax Reform Act of 1986 where Ronald Reagan signed that into law that caused the first 50% of Social Security income taxable. And then it was Bill Clinton that took that up to an 85% rate. But those numbers, the $32,000 and the $44,000 we talked about earlier, they’ve remained exactly the same even though they try to go back to live today on what you were making in 1986. Your standard of living would be far lower on the same income. In other words, we’ve had inflation. And so, you’re right. That number needs to go up. Those numbers should have been being indexed with inflation all along. They’ve indexed the amount of Social Security wages that are taxed with inflation, but they haven’t adjusted this.

[00:16:38] Ken Sokol: You might mention that the original intent of taxing Social Security benefits for higher-income individuals was to extend the longevity of the fund. It was projected back in the 1980s and 1990s that the Social Security Trust Fund was going to run out of assets. The purpose under Ronald Reagan was to go, “We’re going to tax that.” The tax that is collected off of Social Security benefits goes into the Medicare and the Social Security trust funds.

And then again, the studies came out, and to the 1990s that it’s still not enough to help shore up that fund, the trust fund. So, they move that tax up to 85%. And again, the revenue generated from those taxes go into the trust fund. But that alone, along with the interest and the taxes FICA is not enough to keep the trust fund whole. That’s still projected that the trust fund will be depleted. This is a joint trust fund, joint between disability and Social Security, that will be depleted in 2034.

Keeping the Social Security Trust Fund Afloat

[00:17:52] Dean Barber: Yeah. And that number keeps moving depending upon some I’ve heard as early as 2032, 2034. But you’ve got some recommendations to this NASI group of ways that I think, first of all, there’s education but we’ve also got to make sure that the trust fund is solvent. In my view, the money that you contributed and the money that your employer matched dollar-for-dollar would be like you are putting money into a 401(k) and your employer is making a 100% match to your contributions.

Social Security is Your Money

That’s the way I look at it because it’s your money, right? If that was a 401(k) and you were able to manage that 401(k) and get some reasonable returns on that over your lifetime, the pool of money that you have would be huge. The attention that you would pay to that would be even bigger because you’d say, “That’s my money. I need to make sure I treat it right.”

Yet most people think that the claiming age for Social Security is synonymous with the day that they retire and they think that it’s an entitlement program. It’s not an entitlement program. It’s your money. You put it in there and your employer made a dollar-for-dollar match. So, what you found was that you better pay a close attention to how you claim Social Security because how you claim it will determine how much you get back out of the money that you put in.

[00:19:17] Ken Sokol: You’re absolutely correct. We can go back a little bit when I first got into this. The deficit to the trust fund between the income and the outflow if they were to adjust the Social Security for the employer and the employee by 0.9%, they would have fixed the problem in perpetuity.

Will the FICA Deduction Get Raised?

Since we have not done anything to adjust the FICA or any other changes to fix the forthcoming depletion of the account, that’s up to 3.54%. Now, take that per person that’s going to be about 1.75%. Currently, you’re paying 7.62%. That number would now have to go up to, for an individual, 1.75% up to 9.4%, in that ballpark. Had they taken care of it 10, 12 years ago, it would have been much smaller. The further we delay correcting the program, the more onerous it’s going to be when it’s turned on.

That’s not the only solution to increase the FICA deduction but it could be decreasing benefits, moving it now from 67 as a start for your full retirement. It could be moved up to 68, 69, even higher. They’ve talked about reducing spousal benefits, they’ve talked about reducing child benefits for minors that have lost a parent. But in addition to talking about Social Security as being a 401(k) equivalent or a savings plan. This is why a lot of people said, “I would have done better had I had the money and put it into an investment account.” Well, it does provide insurance, disability insurance, and death benefit insurance. That goes out to a lot of people. Now, the average age for somebody receiving disability is 55.

[00:21:16] Ken Sokol: I’ve known a number of cases where people picked up disability or survivor’s benefit off their parents as a minor. There are a lot of other aspects. People say, “If I had it to invest and I live that long and I didn’t need the insurance, I’d be better off.” But I think Social Security has been a fantastic program ever since it started.

Social Security as a Financial Planning Tool

[00:21:41] Dean Barber: I agree with you. And you know, it’s interesting because it was in 2008 when we had the Great Recession that I should step back and I said, “You know, there’s something I’ve missed. I haven’t thought of everything in the retirement planning process.” And so, we start going in and exploring all these different ways that people can get income and we really honed in on Social Security. What we found was the same as you.

It’s just like, “Oh my God, there are so many ways that people can do this. The difference between the best and worst decisions can mean $100,000 or more of additional income on the same earnings over the lifetime and the same life expectancy.” So, it was enormous. This is something that everybody that’s heading into retirement should be paying attention to. They should be making this plan on how they’re going to claim and when they’re going to claim, not after they retire, but they should be doing it four or five years leading up to retirement.

[00:22:41] Ken Sokol: You’re exactly right. Planning in your final stages as you approach retirement to structure your accounts, to structure not much you can do with Social Security but if you have a spouse that’s maybe a non-working spouse that may have eight years of credit, another year to put four more credits into the box and qualify for their own personal benefits. There are these different tables for when you take spousal benefits early or late. There’s this different table when you take your own. There are so many different aspects. I don’t expect that my children or my children’s children are going to have the wherewithal to go into all those calculations. They’re going to need to come back to somebody that’s got the wherewithal to do that for them.

Financial Planning is Not All About Investments

[00:23:31] Dean Barber: Yeah. I think before people always say, “Look, hey, Dean, you’re a financial planner. That means you’re my investment guru.” But really, we don’t ever talk about investments until we’ve gone through the complete financial plan, figured out how we’re going to maximize Social Security, what’s our distribution strategy based on the buckets of money that people have. They have taxable, tax-deferred, and tax-free. What’s the order in which we should take those?

How do we make our taxes as low as possible throughout the retirement lifetime? Until we’ve done those things, we can’t even answer the riddle of what does the investment need to do in order to fill the gap of the desired income versus what you’re going to have. And I think that so many people get it backwards because a lot of people in my industry are trained by Wall Street and big financial institutions to get people to invest as much money as you can and keep it in as long as you can, die with a mattress full of money that you could have actually enjoyed. And I think, man, that’s not what that’s all about. We should be able to enjoy it. And let’s do it right and let’s give ourselves some reward for the sacrifices that we gave over the years.

How Social Security Fits in the Overall Financial Planning Puzzle

[00:24:37] Ken Sokol: I mentioned one other thing that I often see and I looked at a lot of research material, a lot of articles, and one that I often see is, “Shall I take money from my traditional IRA first or shall I take it from my Roth IRA first?” They’re asking the wrong question. It’s not an either-or question. I just look at that and every time I see that article or that proposal or that question raised and say that they’re missing the point. It’s not an either-or question. It’s how much out of each one do I take to minimize my taxes going forward. And it’s a mixture of the two.

[00:25:19] Dean Barber: That’s right. I’ve always said as long as you live in the United States and have money or make money, tax will be a fact of your life. You should never step back and say, “How do I save as much in taxes as I can this year?” You should be saying, “How do I save as much as I can in taxes over the long term?” The only way you do that is with a proper financial plan, sitting with the CPAs, understanding the impacts of Social Security. It’s a complicated puzzle that’s different for every individual.

[00:25:43] Ken Sokol: I think you’re hitting on all cylinders. I’m doing the same thing for myself.

[00:25:48] Dean Barber: Right. There’s work involved. As you know, it’s not a simple as plugging a couple of calculations into a computer and, voila, here’s your answer. You need got to go through all the different iterations. You need to run all these different simulations and come up with what’s the right answer for each individual.

Helping People Claim Social Security

Ken, as you have had people come to you that are not financial advisors, I know you traveled all around the country speaking in front of financial advisors as you started to come up with this, “Oh my gosh, there’s so much more here. Financial advisors need to know this.” But now, in the 17 years where you’ve been preparing taxes for people, you’ve got a lot of people that are asking you how to claim their Social Security. When should they take it? That’s got to be kind of a humbling deal but it’s also a huge responsibility.

[00:26:35] Ken Sokol: And one that I kind of shy away from because I typically provide some consulting services to organizations, life insurance companies, etc. I have shied away from doing that individually. I kind of steer them in one direction or another, but I try to avoid that. But I’ve got to come back. You need to find somebody that can do this stuff for you. It’s not an easy task. That’s one of the things my recommendation to Social Security is to provide more information to educate clients, to educate people.

Starting out at a young age when I first got my first paycheck, “Hey, I’m missing 7.5% of my income is gone. What is that?” And I don’t know why and how is it working and is that going to be today? Is that tomorrow or is that forever? And if there’s a benefit there, what is that benefit?

Financial Literacy is Crucial

[00:27:37] Dean Barber: Yeah. The education system needs to change. Let’s go back even into high school and college, where we need to have a requirement for financial education, personal financial education so that people can understand this. You know, you get people coming out with a liberal arts degree. Even my daughter who graduated with a dual degree in Spanish and Chinese and, as you know, done some amazing things, she’s like, “Dad, nobody taught us any of this stuff in school. They didn’t teach us what a 401(k) was. They didn’t teach us how we should be doing those things.”

And it’s all like, “Oh, well, you should figure it out.” And then what happens is the companies, they rely on their H.R. department to provide some level of education or some level of information, and they expect that, “Well, you got your college degree. You ought to be able to figure it out.” The same thing goes with Social Security and with taxes. How does all this stuff work? Should I be doing a Roth now or should I be doing a traditional now?

And you can’t answer that question until you ask the question, when are you going to retire and how much money are you going to need? Then you can determine which one’s best to put money into today. So, it always is kind of like you got to start with the end in mind all the time and don’t put any money into anything until you know when are you going to take it out? And what’s your situation financially going to look like when you go to take it out? And of course, there’s no crystal ball. You don’t know those things for sure, but you need to ask those questions to make the educated decision on where you should be going today.

[00:29:09] Ken Sokol: In my senior years and I may be stepping down from this but I can’t get away from it. Every time I turn around and say, “I’m ready to walk away,” I’ve got more people with more questions and asking for more input.

Better Off Understanding the Rules Around Social Security to Avoid Making Mistakes

[00:29:25] Dean Barber: So, a personal question for you. This is just something that’s interesting to me. You retired at 54. You’d be…

[00:29:34] Ken Sokol: 75 next month.

[00:29:35] Dean Barber: Okay. So, you’d be 75. Has your work on Social Security and the taxation of Social Security and the distribution planning, has that work helped keep you mentally sharp and really been fulfilling for those retirement years?

[00:29:58] Ken Sokol: Yes. I’m fortunate enough to say that I’m better off having done this, better off than when I’ve walked out the door at Hallmark. It’s kept me very active. I do a lot of other things in addition to this but it’s a small minor part, but that does keep me going. And to think that I’m in this Washington, D.C. think tank now, I think whatever I can do to contribute to the program going forward, I think Social Security is going to be here for a long period of time.

Adjustments Need to Be Made to Social Security

[00:30:38] Dean Barber: I do too. They’re going to have to make the adjustments that need to be made in order to be able to keep it solvent because it’s too important. But it seems like every time a politician starts to talk about it, it’s like political suicide for him.

[00:30:50] Ken Sokol: And there are two sides of that fence that’s in the middle of Congress. Are we going to increase the benefits or decrease the benefits or increase the taxes? And again, it’s like most everything. It’s not a black or white issue. It’s a gray issue. There’s lots of things to do. It’s going to be a little bit of increase in here and a little bit of taken away here. But we do have to fix it in the long term. The longer we put it off, there hasn’t been a big bump this last year just because of COVID on the amount that it’s going to take to fix the program. But the sooner they do it, the better off we’ll all be. And maybe a lot of public awareness will be the encouragement that they need to get something done.

The Social Security Administration Makes Mistakes Too

[00:31:39] Dean Barber: Let’s talk about one other thing before we wrap this up, Ken. This is a frustrating thing for me, as well as pretty much every person that goes in to claim their Social Security. And that is that the people at the Social Security offices are not allowed to give you advice on how you should do it. They’re going to give you, “Here are your options. You’ve got to choose,” but they don’t even give you all the options. They give you the very basic options from 62 to 70. They don’t talk about the mixing of spousal benefits, and they don’t talk about longevity. And people, I think, are under the impression that if I go talk to somebody at the Social Security Administration, I’ve done my homework and now I have the right answer. What do you say to that?

[00:32:20] Ken Sokol: I’ve gone to the Social Security office a number of times, not just for myself, but in pursuit of more information and more details. I’ve been given incorrect information and when I walked away knowing that I was given the incorrect information and I received a personal phone call from an agent saying, “I made a mistake. I haven’t kept up with the changes that were going on and I gave you the wrong information. And I don’t know how many people I’ve told that to.”

The SSA Doesn’t Have All the Answers

I’ve been in lectures by representatives from Social Security and it’s a plain Jane format, just explaining a little bit about Social Security, but never talk about the delayed retirement credits or the tax structure, etc. That’s one of the proposals that I would make is to provide an open forum.

When I’ve gone to a lecture more recently to church groups and other groups about Social Security, I have someone in the audience that is missing out on significant amount of benefits. I have to inform them. I said, “I think here’s the benefit that you’d be looking for and you need to go down there. You need to request the benefit. You need to have this information.” The Social Security website has a ton of information on it and it’s getting better every year. They’re coming out with a new statement format that’s going to provide more information, more of what I call a staircase of my benefit at 62, 63, 64, and give you more detail. Nothing in that format is talking about the other part of the government where the taxing part. So, there are two different organizations

[00:34:18] Dean Barber: You need to be married together. For your plan, for the personal plan, you need to be married together.

Do Your Due Diligence and Find the Help You Need

[00:34:21] Ken Sokol: I think down the road that we need to do our due diligence. When I first got into this, my financial planner that I was sharing this information with said, “You need to share this information. Push this out so that everybody can know about it. And know that there are some other options and take advantage of them. And after all, it’s your money and it’s just how you want to take it one way or the other. We want to do everything correctly and above board but they’re for your own benefit. Delaying this here to pick up an 8% more next year, that’s a pretty good deal for most people.”

[00:35:11] Dean Barber: It’s a big deal. It really is. Ken, I certainly appreciate you taking time to visit with us about your journey through retirement. Thanks for all you’ve done for the financial industry by bringing awareness to Social Security claiming strategies and their importance. Congratulations on your success at Hallmark and being able to retire at a very young age. I’m happy that you’ve been able to have a very fulfilling retirement thus far. Thanks for being here.

[00:35:42] Ken Sokol: Thank you. I’m glad to. And maybe again some time down the road.

[00:35:45] Dean Barber: Absolutely.

[CLOSING]

Download the Social Security Decisions Guide or Reach to Us

[00:35:48] Dean Barber: Thanks so much for joining us here with The Guided Retirement Show™. Of course, in the show notes, you will find a link to our Social Security Decisions Guide. And also through that link, you’ll be able to request a complimentary consultation with one of our CERTIFIED FINANCIAL PLANNER™ professionals so that we can help answer your questions when it comes to your specific Social Security. Thanks for joining us on The Guided Retirement Show™.

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