FA Playbook

These big mistakes will result in smaller Social Security checks

Sarah O'Brien, special to CNBC.com

If you think Social Security deserves little thought in retirement planning, think again.

A new study shows that many people approaching retirement or already retired have misunderstandings or misconceptions about Social Security. And the result, experts say, can be less income or unexpected taxes for retirees.

"Our parents and grandparents had pensions, but they are drying up and going away," said David Giertz, president of distribution and sales at Nationwide Financial Distributors. "So it's more important than ever to … create a retirement income plan that includes [maximizing] Social Security benefits."

Donald Higgs | Getty Images

The study, conducted by Nationwide Retirement Institute (click here to download), shows that 30 percent of people already retired are receiving a benefit that's less than they expected. This is up from 22 percent in 2015.

Roughly 900 people age 50 or older were surveyed for the study and separated into three categories: future retirees (planning to retire within 10 years), recent retirees (under 10 years into retirement) and 10-plus retirees (retired for 10 years or more).

Of the future retirees, 86 percent failed to accurately identify the factors that go into determining the amount of your Social Security benefits.

One of the biggest misconceptions that financial advisors routinely see deals with age.

"We see a lot of people who think that because age 62 is when they can start taking Social Security, they should," said Robert Seiler, a financial advisor and vice president of ASC Financial Group. "We call it the 'land-grab mentality' — it's there, you can take it, so you do."

Social Security was designed to assist in retirement, not entirely fund it. So you need to have a ... retirement plan to follow.
Robert Seiler
vice president of ASC Financial Group

But, Seiler and other advisors caution, you could be leaving lots of money on the table. Although eligibility for Social Security benefits starts at age 62, full retirement age — as viewed by the government — ranges from age 65 to 67, depending on your year of birth. Waiting until your full retirement age, or delaying benefits beyond that, results in a bigger monthly check.

For illustration purposes: Assume your full retirement age is 66, at which point you're due a monthly benefit of $1,000. If you choose to get checks starting at age 62, your monthly payment will be reduced to $750, or a 25 percent reduction.

"Some [prospective clients] know there's a reduction in benefits before their full retirement age, but they don't understand exactly how much of a reduction it will be or that it's permanent," said Willie Schuette, an investment advisor representative with The JL Smith Group.

(You can only change your mind about filing early if you do it within a year of when you start receiving benefits. But, you must refund anything you received.)

On the other hand, if you wait to take your benefits beyond your full retirement age, they will grow by 8 percent of the full retirement amount each year.

(Source: Nationwide Retirement Institute Consumer Social Security Study, June 2016)

So if full retirement is age 66 and you wait until age 70 — when benefits stop increasing — your monthly benefit will be $1,320 instead of $1,000, or 32 percent more than that $1,000. And if that $1,000 were, say, $2,000, waiting until age 70 would mean $2,640 a month.

Taxation is another area where misconceptions abound.

"Social Security is taxed; that surprises some people," Schuette said, explaining that the government has income thresholds for what is taxed, but that no one pays taxes on more than 85 percent of their benefits.

People also are often surprised to discover that if they take Social Security before full retirement age and continue working, they might have to pay taxes on that income. In that scenario, the government will deduct $1 from your benefit payments for every $2 you earn above the annual limit. For 2016, that amount is $15,720.

"Once you reach full retirement age, any income you earn isn't held against you from a taxation standpoint," Schuette explained. "You can earn as much as you want."

Schuette points out that many people are in a position of having no choice but to start getting Social Security at age 62 due to insufficient savings or an unexpected life event, such as a medical condition.

In fact, Nationwide's Giertz points out that his firm's study found 37 percent of retirees — both recent and longtime – say health problems prevent them from living retirement as they envisioned it. Also, health-care expenses keep one in four current retirees from living the retirement they expected.

Additionally, 80 percent of recent retirees say those health problems arrived earlier than expected. But, the study says, retirees who work with an advisor are less likely than those who don't to say health problems keep them from living the retirement they expected (25 percent vs. 41 percent) and also are less likely to say health care costs keep them from living the retirement they expected (11 percent vs. 29 percent).

Overall, experts say that while maximizing your Social Security benefits is important, it is only one piece of retirement planning.

"Social Security was designed to assist in retirement, not entirely fund it," said Seiler of ASC Financial Group. "So you need to have a [comprehensive] retirement plan to follow."

— By Sarah O'Brien, special to CNBC.com

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