Viewpoints on Financial Planning
Social Security, or the Old Age Survivors Disability Insurance Act (OASDI), was enacted in 1935, partially in response to the Great Depression. Payroll (FICA) taxes began in 1937 and the first monthly retiree benefits began in January 1940. With the large number of people entering their retirement years combined with longer life expectancies, much has been written recently regarding fears that the current program cannot be sustained without modification.
Given the importance of Social Security for more than 55 million beneficiaries, along with the potentially large lifetime benefit it provides to those who are eligible, a thorough examination of common questions and misconceptions about Social Security is warranted.
1. Is Social Security becoming insolvent? Will it be there when I need it?
Each year the trustees of the Social Security trust fund report on the current and projected financial status of the program. In 2011, they acknowledged that the financial condition of the Social Security program remains challenging, and that projected long-run program costs are not sustainable under currently scheduled financing. There are currently 3.2 workers for each Social Security beneficiary and, as it stands today, the number of beneficiaries is growing at a faster rate than the number of covered workers. By 2034, it is estimated that there will be 2.1 workers for each beneficiary. Trust fund reserves are expected to be exhausted by 2036. After that time, anticipated tax revenues will be sufficient to pay approximately 75% of scheduled benefits through 2085.
An alternate way to think of the costs of Social Security is in relation to taxable earnings, since the primary source of income for OASDI is the payroll tax. The costs of Social Security are projected to grow from 13.4% of payroll in 2010 to 17.01% of taxable payroll by 2035. There is a slight projected decline in costs in 2050, and then a gradual rise thereafter, reaching 17.56% of taxable payroll in 2085. The trustees have recommended legislative action so there is no major disruption for beneficiaries or tax payers going forward.
2. Are the payments too small to worry about?
According to the Alliance for Retired Americans, Social Security replaces about 42% of an average wage earner’s pre-retirement income and approximately 26% of a high wage earner’s income. Each beneficiary’s specific benefit is based on his or her average earnings over the course of a full working career along with the age at which benefits commence. In 2013, the average monthly benefit paid to retirees is approximately $1,261 per month ($15,132 per year). The maximum Social Security benefit a worker retiring at full retirement age in 2013 might expect to receive is $2,533 per month ($30,396 per year).
These numbers might not seem sufficient on the surface. However, in today’s low interest rate environment (e.g., a 10-year US Treasury Bond at 1.84%), it would take approximately $822,400 to replace the income the average retiree receives ($1,261/month) and about $1,652,000 would be required to generate the maximum monthly benefit ($2,533). By considering the dollars needed to replace the amount of income it provides, it is easy to see that Social Security is an important piece of the retirement income puzzle and should not be ignored.
3. How do I qualify for benefits?
When you work and pay Social Security taxes, you earn a maximum of four credits each year toward Social Security benefits. If you were born in 1929 or later, 40 credits (or 10 years of work) are needed to become eligible. In 2013, the amount of earnings needed to earn one Social Security credit is $1,160 (or $4,640 for the maximum four credits in a year).
Benefits are calculated based on an average of your highest 35 years of earnings, up to the earnings limit in the applicable year. The amount of taxable earnings subject to the Social Security tax (called the maximum taxable earnings limit) is $113,700 in 2013. Your specific benefit in retirement is based on how much you earned during your working career. Higher lifetime earnings result in higher retirement benefits, but not in excess of the maximum tax earnings limit in the year of receipt.
There are circumstances under which family members might qualify for retirement benefits as well, even if they have not earned a full 40 credits under their own records. For example, a spouse who has not worked or who has lower average earnings might be entitled to as much as one-half of the retired spouse’s full benefit (reduced to as little as 35% if taken prior to full retirement age). A widow or widower at full retirement age might receive as much as 100% of the deceased spouse’s benefit or a reduced benefit as early as age 60.
Generally, you cannot receive widow or widower benefits if you remarry prior to age 60. However, remarriage after age 60 does not preclude you from receiving benefits under your former spouse’s record. In the event of divorce, ex-spouses over age 62, if married for at least 10 years prior to divorce, are also eligible for benefits under a former spouse’s record.
4. When can I begin taking benefits?
Your full retirement age depends on the year in which you were born. You can elect to start taking payments as early as age 62. However, if you start Social Security benefits before your full retirement age, monthly benefits will be reduced by 5/9ths of 1 % for every month between your retirement date and your full retirement age, up to 36 months, then by 5/12ths of 1% thereafter. To illustrate, if your full retirement age is 67, you’ll receive about 30% less if you retire at age 62 than if you wait until age 67 to retire.
|If you were born in:||Your full retirement age is:|
|1955||66 and 2 months|
|1956||66 and 4 months|
|1957||66 and 6 months|
|1958||66 and 8 months|
|1959||66 and 10 months|
|1960 or later||67|
Conversely, you might also choose to defer benefits past your normal retirement age to receive an even larger amount in the future. Depending upon the year you were born, for each month that you delay receiving Social Security retirement benefits past your full retirement age, your benefit will be increased by a certain percentage. For example, if you were born in 1943 or later, your benefit will increase 8% for each year that you delay receiving benefits. Working past your full retirement age also allows you to increase your Social Security earnings record, thereby potentially allowing you to receive a higher benefit when you do retire, especially if your earnings are higher than in previous years.
5. When should I begin taking benefits?
With Social Security, customized guidance is essential. It is all too common for people to begin drawing Social Security at their earliest opportunity, without realizing what other options are available. In fact, according to a report to the Chairman of the US Senate’s Special Committee on Aging presented in June 2011, 73% of retirees apply for Social Security prior to their full retirement age, thereby permanently limiting their expected lifetime benefits. Since a couple aged 65 today has almost a 47% chance that at least one partner will live to his or her 90th birthday, and a 20% chance that at least one will live to his or her 95th birthday, permanently reducing payments might not be the best choice. Source: GAO-11-400, Retirement Income, June 2011, data compiled by the SSA Office of the Chief Actuary
At its simplest level, a break-even analysis can help you determine the age at which the cumulative benefits of beginning distributions at various ages exceed one another. In the example that follows, a client might receive a reduced benefit of $1,759 per month at age 62, or an enhanced benefit of $3,862 at age 70. Should the person live past age 78, the cumulative effect of having waited begins to pay off, resulting in more than $375,000 in extra benefits by age 90 ($1,300,000 - $925,000).
|Simple Break-Even Analysis|
|Enter the earlier age benefits may be claimed||62|
|Corresponding monthly benefit amount||$1759.00|
|Enter the later age benefits may be claimed||70|
|Corresponding monthly benefit amount||$3682.00|
|COLA % (annual cost-of-living adjustment)||2.80%|
|Age||Monthly benefit if start at earlier age||Annual benefit if start at earlier age||Cumulative benefit if start at earlier age||Monthly benefit if start at later age||Annual benefit if start at later age||Cumulative benefit if start at a later age|
A further point to consider when contemplating early Social Security income is whether or not you plan to continue working. For years before your normal retirement age (2013 limits), benefits will be reduced $1 for every $2 of earnings over $15,120. In the year you reach your normal retirement age, a limit of $40,080 applies. Earnings over the limit result in a reduction of $1 for every $3 excess earnings. After normal retirement age, continued earnings do not cause a reduction. Earnings that might reduce your benefit include wages you earned as an employee, net earnings from self-employment, and other types of work-related income such as bonuses, commissions, and fees. Earnings that will not reduce your benefit include pensions and retirement pay, workers’ compensation or unemployment benefits, prize winnings from contests, unless they are part of a salesperson’s wage structure, tips that are less than $20 per month, payments from retirement accounts, investment income, or income earned in or after the month you reach normal retirement age.
6. What are some ancillary strategies that we might wish to consider?
By coordinating benefits with one’s spouse and considering all of the options available as part of an overall financial plan prior to beginning distributions, maximum benefits might be realized. In addition to typical strategies involving drawing early, at full retirement, or at a delayed retirement date for an increased benefit, spouses might also consider the less-frequently utilized options of claiming now and claiming more later, or filing for and suspending benefits to increase their overall return. When considering these options, please remember that a spouse cannot begin taking spousal benefits unless the worker has claimed under his or her own record. Also, these more creative strategies will not work prior to full retirement age.
File and Suspend: Your spouse cannot receive spouse’s benefits until you file for retirement benefits. However, if you are of full retirement age, you can apply for retirement benefits and then request to have payments suspended. That way, your spouse can receive a spouse’s benefit and you can earn delayed retirement credits until age 70.
Alternatively, to claim now but claim more later, a high-earning worker might claim a benefit under his or her spouse’s record at age 66, and then switch to his or her own higher benefit at age 70.
Which of these scenarios (or combination of techniques) is best for a given family depends on a number of variables and what the family is hoping to accomplish.
In the following hypothetical example, Albert and Jean Smith are both 62 years old. Albert’s benefit at full retirement is $2,200, while Jean’s is $800. Albert has a life expectancy of 86 and Jean’s life expectancy is 91. They are interested in determining the optimal time to start taking Social Security. If they were to both begin taking benefits at age 62, their cumulative total combined income by Jean’s age 90 would be approximately $1,315,808, assuming an average 2.8% annual cost of living increase. This is about $230,000 less than if they were to both start drawing at age 66.
As an alternative, Jean might consider drawing under her own record at age 62. If Albert were to then file and suspend his at age 66, Jean might be able to begin drawing a higher spousal benefit at that time. Finally, Albert might begin drawing an increased delayed amount at his age 70. The combination of these strategies results in a cumulative benefit at Jean’s age 90 of $1,641,603, significantly more than the other alternatives.
|Both take benefits at age 62|
|Both take benefits at age 66|
|Jean takes benefit at age 62. Albert files and suspends at age 66. Jean starts spousal benefits at age 66. Albert take his own benefit at age 70.|
7. What income tax consequences exist relative to the receipt of Social Security benefits?
Social Security benefits may be partially taxable, depending on your other sources of income. In fact, about one-third of people who receive Social Security pay income taxes on their benefits. A taxpayer whose modified adjusted gross income plus one-half of the Social Security income exceeds either of two threshold amounts is taxed on a portion of Social Security benefits received that year:
- For married taxpayers filing a joint return, the base amount is $32,000. If your provisional income exceeds this amount, then you may have to pay taxes on 50% of your benefits if you and your spouse have a combined income that is between $32,000 and $44,000. If your combined income exceeds $44,000, up to 85% of the Social Security benefits may be taxable.
- For married taxpayers living together for part of the year but filing separate returns, the base amount is reduced to zero and taxes on any Social Security benefits will likely be owed.
- The threshold for all other filers (single, head of household or qualifying widow[er]) is $25,000. Fifty percent of Social Security benefits may be taxable if your income is between $25,000 and $34,000. If your income is greater than $34,000, up to 85% of your benefit is subject to income tax.
- To help you verify if taxes are owed, at the end of each year the Social Security administration mails a benefit statement, illustrating the amount of benefits received. This can be provided to your accountant or entered into your tax software to determine if you are required to pay taxes on your benefits.
8. Does Social Security provide benefits for things other than retirement?
While this article has focused primarily on the retirement income that Social Security provides, OASDI taxes also pay for disability and survivor programs administered by the Social Security Administration.
If you have a mental or physical condition that prevents you (or is expected to prevent you) from working for more than a year or is predicted to result in death, you might be eligible for Social Security disability benefits, as long as you have enough credits to qualify. There is no age limitation, but the number of credits required to qualify depends on the age at which you became disabled. Normally you need 40 credits, 20 of which were earned in the last 10 years, ending with the year you became disabled. However, those who are disabled before age 31 might qualify with fewer credits. An adult disabled prior to age 22 may qualify under his or her parent’s record. Payments cannot begin until you have been disabled for at least five full months, but it is recommended that you file your claim early, as it can take several months to process. Generally, disability payments continue as long as your medical condition has not improved and you remain unable to work.
If you are deemed eligible for Social Security disability payments, your children might also qualify to receive payments under your record. To qualify, the child must be under age 18 (or 19, if still in high school), or be 18 or older, but suffering from a disability that started before age 22. Each child might receive up to one-half of your full disability amount. A spouse caring for children who are under age 16 is also potentially eligible for a benefit under the disabled worker’s record. Unless the spouse is 62 and becomes eligible for early spousal retirement benefits, the spouse of a disabled worker will stop receiving payments when the youngest child reaches age 16. Children’s benefits continue until they reach age 18 (or two months after they turn 19, if still in secondary school).
The combined family payments cannot exceed a maximum of 150% to 180% of the disabled worker’s payment.
OASDI taxes provide for some survivor benefits when a covered worker passes away. In addition to the retirement widow or widower benefits previously discussed, benefits can be paid to your children and a spouse caring for your children under age 16. Your surviving family members may be eligible for benefits as long as you have earned credits for at least 1½ years of work (six credits) in the three years before your death.
Your widow or widower might receive reduced benefits as early as age 60 (or as early as age 50 if he or she is disabled). Remarriage before age 60 impacts benefits; however, remarriage after age 60 will not. In addition to his or her own survivor benefits, a spouse who has not remarried and is caring for children under age 16 can receive survivor benefits at any age.
Children under age 18 (19 if still in high school) can also receive benefits under your record when you die, as can a child who is disabled prior to age 22. How much your family receives depends on your lifetime earnings and is capped at 150% to 180% of your basic benefit amount. This amount can be found on a Social Security estimate statement, mailed to you each year before your birthday, or by visiting www.socialsecurity.gov and using the calculators on the website. If the total benefits due to your spouse and children are more than the maximum allowed, the benefits will be reduced.
For more information about Social Security programs and to receive estimates of the options available to you, please visit www.socialsecurity.gov or contact a representative at 800-772-1213.