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Question: How can we negotiate divorced spouse benefits under current Social Security rules?
Answer: Under Social Security rules as amended in November, 2015, a divorced spouse may not claim divorced spouse benefits unless the worker spouse is also claiming benefits.
(The divorced spouse benefit is 50% of the worker spouse's benefit, and applies only if the parties have been married for 10 years or more, the divorced spouse is age 62 and typically not re-married, and the worker spouse is entitled to claim benefits.)
This FAQ discusses current law, an approach to the resulting negotiation, and when the parties should claim benefits.
Although both spouses are divorced from each other, for simplicity, we are calling the spouse who would be claiming the 50% benefit the "divorced spouse," and we will call the spouse on whose earnings record the claim is based the "worker spouse."
Previously, a divorced spouse could claim divorced spouse benefits as long as the worker spouse had reached age 62, regardless of whether the worker spouse was claiming benefits.
Now, a divorced spouse may claim divorced spouse benefits only if the worker spouse is also claiming benefits.
This may pose a dilemma, because the worker spouse may wish to delay claiming benefits in order to maximize the benefit ultimately paid. But the divorced spouse may need the money and want the benefits to start sooner.
This then would become another negotiation in the divorce settlement.
An Approach to Negotiation
One approach which might work would be if the divorced spouse promised to pay the worker spouse the difference out of the divorced spouse's Social Security benefit.
But calculating the difference is easier said than done.
For example, suppose the parties agree that the worker spouse will start collecting age 62. The worker spouse thus forgoes the increased benefits that the worker spouse would receive if the worker spouse waited until age 70.
Suppose, however that the parties agree that the worker spouse will start collecting at age 62, but that, starting at age 70, the divorced spouse will pay the worker spouse the difference between what the worker spouse is actually collecting and the amount the worker spouse would have collected if the worker spouse had deferred until age 70.
For example, suppose the payment would have been $1,000 per month at age 67 (regular retirement).
At age 62, the worker would start collecting the reduced benefit of $700 per month.
At age 70, the divorced spouse would start paying the worker spouse $540 per month. This is the difference between $1,240 (which the worker would have received if he/she had deferred starting until age 70) and $700 (which is the worker's actual payment).
This should work for the worker spouse, because the worker spouse has more than he or she would have. The worker spouse ends up with full benefits starting at age 70, but also all of the payments of $700 per month from age 62 through age 70.
This would probably not work for the divorced spouse. When the worker reaches age 70, the divorced spouse would be receiving $350 (half the $700 monthly payment), and would be paying $540.
So this would work for the divorced spouse only if the worker spouse dies before reaching age 70, or does not live much past it.
In reaction to this inequity, perhaps the parties aim to make the worker spouse exactly as well off as the worker spouse would have been if he or she had simply deferred collecting until age 70.
In order to calculate this amount accurately, we would need to know how long the worker spouse is going to live. Usually, we do not know this.
What we can do instead is to use the defined-benefit pension valuation technique. Here are the steps:
1. Create one pension paying the lower amount ($700 in our example), with both regular and early retirement at age 62 (or whenever the person starts collecting). (Enter "date started in plan" as age 20 -- it does not affect the result we care about here.)
2. Create another pension paying the higher amount ($1,240 in our example), with regular and early retirement at age 70 (or whatever later date would have been contemplated).
3. If the pension that starts earlier has a higher present value (ignore the coverture fraction and look at total value), then no payment needs to be made, because the worker spouse is better off anyway starting earlier.
4. If the pension that starts earlier has a lower present value, then the non-worker spouse could pay the worker spouse the difference in present value. This could be paid in a lump sum or over a period of time.
Continuing our example from above, for a worker born 1/1/1980, using the RP-2000 table and a 2.5% discount rate, the later-retirement pension has a value of $81,871 and the early-retirement pension has a value of $75,495. So the lump sum payment that would need to be made is the difference, or $6,376.
(Note that we are looking at the pension total values, here, NOT the marital portion.)
This calculation attempts to make the worker spouse as well off as he or she would have been before the law change, as if the divorced spouse's choice of when to claim benefits were independent of the worker spouse's decision.
One final note: if the parties have other income, a part of the social security payment would be taxable. And the payment from one spouse to the other would be categorized as alimony. So there may be tax consequences that make the situation a bit more complicated.
When to claim
As before, this is a numbers game, but the game has become a bit more complicated.
For one person deciding when to file, the longer the person expects to live, the more it makes sense to defer starting to collect, so the person gets the benefit of the larger monthly payments. After some number of payments, this larger benefit makes up for the fact that years of payments were lost by delaying the start date.
We compared the present values of social security under three scenarios: earliest retirement, regular retirement, and age 70 (latest retirement for which credits are available).
The assumptions underlying this analysis are:
- Basic retirement age is 67.
- Discount rate is 2.5%
- Monthly benefit is $1,000.
Under these assumptions, we get the following results:
- If you are not going to live to age 82, then starting at the earliest (age 62) is your best bet.
- If you are going to live to an age between 82 and 86, then starting at regular retirement (age 67) is your best bet.
- If you are going to live past age 86, then delaying until age 70 is your best bet.
These conclusions are sensitive to the discount rate. For example, if the discount rate is 1.5%, then:
- If you are not going to live to age 81, then starting at the earliest (age 62) is your best bet.
- If you are going to live to an age between 81 and 88, then starting at regular retirement (age 67) is your best bet.
- If you are going to live past age 88, then delaying until age 70 is your best bet.
According to data compiled by the Social Security Administration:
A man reaching age 65 in 2016 can expect to live, on average, until age 84.3. A woman turning age 65 in 2016 can expect to live, on average, until age 86.6.
With this information, one could summarize the result of our calculations as follows: if you are in poor health, start claiming at age 62. If you are in average health, start claiming at regular retirement age. If you are in better-than-average health, then defer claiming until age 70.
If there are two people involved, it becomes more complicated to determine when to start. But if both are in poor health, then it may make sense to start collecting as soon as possible. If both are in better-than-average health, then it makes financial sense for both to defer. But if they cannot, then perhaps a pension valuation calculation like the one above may be helpful.