The Social Security "Pay Cut" at DeathSubmitted by Orange CA Financial Advisor | Sterling Wealth Partners on August 30th, 2016
Social Security is very often the cornerstone of a retirement income plan. It is an important benefit that provides inflation adjusted income that the client can't outlive. But, with a married couple, once one spouse dies, that income is going to drop resulting in a "pay cut" for the surviving spouse.
Consider this example: John & Mary have both reach their full retirement age and will start receiving Social Security benefits. John's primary insurance amount or PIA is $2,000 and Mary's is $1,000. So as a couple, they have $3,000 of monthly income from Social Security. Now let's assume John dies 10 years later. His personal benefit stops, but Mary is allowed a survivor's benefit equal to John's benefit if that is higher than her own personal benefit. In this case, Mary would receive a $2,000 survivor's benefit but would not receive her $1,000 personal benefit. So the result is Mary's monthly income has now dropped from $3,000 to $2,000, a 33% pay cut. Mary's monthly expenses may drop due to John's death, but it is pretty likely that they won't drop by 1/3. This creates a cash flow issue for Mary that probably wasn't considered when they calculated their retirement needs. If Mary lives another 10 years, that lost income will be $120,000 or more, not a small sum of money to lose.
There are a couple of options to help mitigate the problems caused by the Social Security pay cut. One is to delay claiming Social Security until age 70 to take advantage of the 8% per year delayed retirement credit. This will provide the maximum survivor benefit for Mary and may soften the blow of her lost benefit. The other solution, which can be very cost effective and tax efficient is to buy or keep life insurance. By buying permanent life insurance, the death benefit paid can make up for those lost Social Security payments. So when clients think they don't need life insurance during retirement, keep in mind that the death of their spouse is going to cause a drop in Social Security benefits. Keeping that policy, or buying permanent insurance instead of term can provide an income tax free source of funds to replace that lost retirement income.