Since I received the email reminder from the Social Security Administration on February 10th, we’ve spent the month talking about Social Security with our clients and readers. If you haven’t already logged in to https://www.ssa.gov/myaccount/ to download and review your statement, please do so.
In this post, I will share my Top 5 facts, ideas, and opinions on Social Security. While it doesn’t garner the financial pornography headlines like crypto “assets” (gambling) or market predictions (broken clocks are right twice a day), Social Security is one of Americans’ largest and most valuable retirement planning assets with guaranteed inflation-adjusted income benefits up to $40,000-$50,000 per year.
We have a lot to cover, so let’s jump right in for our Top 5 Social Security Planning Ideas.
1: The Social Security trust fund needs help, but benefits are not going away
2021 is the first year that total costs of the program (benefits and expenses) are expected to exceed income (payroll taxes and interest). Social Security’s trustees and actuaries further expect the “old age” (retirement) income trust funds’ reserves, which are $2.9 TRILLION today, to be depleted in 2033. You can read the most recent trustee letter to the public here.
But all is not lost.
This is not the first time the Social Security system faced difficulties. Starting in 1975, the trust fund started spending down reserves at an alarming rate. That decline eventually led to the Social Security Amendments of 1983 which adjusted the age for full benefits, increased payroll tax rates, and started to include benefits in taxable income. These changes (and a strong bond market) helped change the trajectory of Social Security’s financial stability for the next 30 years.
While Congress has always risen to the occasion of making Social Security tweaks for future stability, it might be a good idea to nudge your Senators and Representative with an email or phone.
Even if Congress does nothing, Social Security expects they will be able to continue paying about 75% of today’s benefits. Not bad for a worst-case scenario.
2: Income is practically tax-free
Let’s say a married couple has the largest amount of Social Security benefit, $50k each or $100k total, and this was their only taxable income. Do you know what their federal taxable income and income tax would be?
$0
This is because the portion of Social Security benefits that are included as taxable income depends on how much total other income you have. The inclusion ratio is between 0% and 85%. Kinda weird, right?
Let’s say this same $100k Social Security benefit couple also has $40,000 of IRA distribution income. Now their taxable income is $57,000 with an income tax amount of $6,500.
You can see how this inclusion rule can lead to some interesting opportunities or pitfalls.
3: Hidden benefits for spouses
Did you know that as a spouse, you are able to receive the greater of your own Social Security benefit or 50% of your spouse’s? Many pre-retirees have no idea.
Surviving spouses have another option of filing for the full Social Security retirement benefit of their decease spouse. This election is independent of their own retirement benefit. This means a surviving spouse can receive their spouse’s benefit starting at age 60 and delay their own benefit until age 70.
Divorced ex-spouses have similar benefits available, but it gets a little more complicated.
4: Taxes and benefits are designed and to help everyone and especially those who need it most
I previously mentioned that an individual’s Social Security benefits are capped at roughly $40,000 (full) to $50,000 (delayed to age 70).
The good news is that payroll tax contributions are also capped - $18,228 for 2022, split 50% between employee and employer. Social Security payroll taxes are 12.4% total, up to $147,000 of an employee’s earnings.
Social Security retirement benefits also pay a higher % of income to lower earning workers who may be less able to save on their own. Retirement benefits are tiered by income level such that workers get a larger income benefit credit for their first $12k of annual earnings, a lessor benefit credit for the next $60k of earnings, and a smaller benefit up to the $147,000 annual earnings limit.
5: You can choose your own adventure
Retirees have the ability to choose the income strategy that works best for them. Granted, this can make things complicated and lead to second guessing. But I value having options available like spousal benefits, early benefits at 62, “full” benefits at age 66-67, and delayed benefits at 70. There are different valid use cases for each option. Having an understanding of your choices and integration with your financial plan can help make the best decision for you.
Social Security is one of the most important tools a retiree has in their income toolbox. It is important to know the choices and features before using it. Our goal is to help clients make the best filing decision(s) so their retirement can be tax-wise, income-smart, and experience-rich.