Social Security 101

Social Security 101

Your erstwhile blogger is becoming more and more interested in the social security (SS) system as he sees his ‘golden years’ quickly approaching through the windshield. So from time to time, I’m going to give you useful information regarding the system that may also aid you in planning with your clients. Having clients bring in an estimate of their projected benefits should become part and parcel of the advice you give your clients. This could also influence decisions made when filing taxes such as accelerating depreciation or, in fact, recommending the client pay more tax to get additional earnings into the social security system.  (These considerations are focused toward self-employed taxpayers).

Factoids courtesy of ssa.gov:

• SS benefits provide a third of retirees with 90% of their income.
• Over 9 in 10 Americans are affected by the SS system, and there are over 34 million retired persons receiving benefits.
• For one-in-five retirees, SS is their only source of income.

Sobering statistics to say the least…

“Marcia, Marcia, Marcia” and “I’d like to buy a vowel”

Both Maureen McCormick (Marcia Brady) and Vanna White (Wheel of Fortune) turn age 62 in 2019! That being said, is it time for them to take their benefits? Maybe or maybe not.

Let’s assume Maureen isn’t working (haven’t seen her in anything for a while). She has been married since 1985. I think we know Vanna is still working as of last evening! She is not married, but was married from 1990-2002.

How are benefits calculated?

SS benefits are based on your past earnings. (I think both Maureen and Vanna might have maxed this area out.)

Steps in the calculation:

1. A summary of the earnings you had throughout your lifetime of work is calculated. This measure is called the Average Indexed Monthly Earnings (AIME). Your wages for prior years are typically indexed, meaning they are adjusted to reflect inflation over the years. The higher your AIME, the larger your benefit.
2. A benefit formula is applied to the AIME to determine your Primary Insurance Amount (PIA). In 2019, you receive 90% of the first $926 in AIME ($833.40); 32% of AIME between $927 and $5,583 ($1489.92 assuming you AIME is at least $5,583); and finally, 15% of AIME over $5,583. The amounts are often referred to as ‘break points.’
3. An adjustment may be made to the amount you are entitled to depending on the age at which you start benefits, the SS earnings test, or other factors.
4. Benefits for dependents and survivors are based on the worker’s PIA. For example, a spouse (or former spouse) may receive a spousal benefit of 50% of the worker’s PIA, and a widow might be entitled to 100% of the worker’s PIA-generated benefit.

Planning Tip. My first planning tip in meeting with a client is to see if projected benefits are at least $2,323.32 per month (which means we hit the full 90% and 32% levels). If not, the client has not ‘maxed out’ the SS ‘sweet spots’ and if possible, should get more earnings into the system.

Let’s get our hands dirty with this…

Lower earning taxpayers receive a higher percentage of their income. (This provision likely wouldn’t apply to either Maureen or Vanna, unless Maureen’s 1970’s money was managed by Macaulay Culkin’s parents or Johnny Depp.)

Retirement benefits are calculated limiting a person’s salary to the taxable wage base for the year. For example, let’s say Vanna will earn $175,000 in 2019. However, the wage base is $132,900. Therefore, the retirement part of the SS system only considers $132,900 of her income. Previously, we saw how the PIA formula used to calculate benefits is weighted so social security replaces a higher percentage of the income of people who earned less when working.  An individual who made about $20,000 (assume Maureen) as average earnings will receive approximately $12,842 per year from SS, which would replace a little more than 64% of her income. In 2019, the maximum monthly SS benefit payable is $3,770 per month. For a wage earner like Vanna (assuming she was always at the maximum wage base), the social security system will replace about 26% of her pre-retirement earnings.

Planning Tip. Once higher earning taxpayers have ‘maxed out’ SS benefits, they should consider other investment vehicles for their ‘extra’ retirement savings.

SSA uses 35 years of earnings to calculate your monthly benefit. (Maureen might have this. Vanna has been on Wheel of Fortune since 1975!)

If you continue to work, you may end up with an increase in your SS monthly payments. Because SS uses 35 years of earnings, you may be replacing an ‘old’ year when you might have worked at McDonalds part-time with higher earnings years. Even though older year earnings are indexed for inflation, they still may be lower than monies you are earning right before you retire. If you don’t yet have 35 years of earnings, SS uses zero wages for the missing year(s) when calculating benefits. You can impact your SS benefit significantly by eliminating a “zero year” with a year with earnings.

Planning Tip. It might make sense for you to work longer…(sorry!)

The limit on how much you can earn and not lose benefits only applies when you take benefits before full retirement age. (If we can assume Maureen is not working, it might make sense for her to start now. Vanna is still working and is likely earning more than $17,640).

For 2019, anyone who is under full retirement age and already claiming social security benefits will lose one dollar in SS for every two dollars they earn over $17,640 (there is a bit of a break though in your first year of retirement). The earnings test only counts wages or net self-employment earnings, and it doesn’t count unearned sources of income like pension, interest, SS benefits, or dividend income. It is important to realize that the earnings test doesn’t apply to earnings after your full retirement age. (I would suggest you review what is considered full retirement age, because it is different for most age groups until you get to persons born in 1960 or after).

Be careful! The annual earnings limit is divided into months ($1,470 per month) so you could lose benefits by working say, in a tax office where you make $17,000 February through April. This averages out to $6,667 per month, which could cause you to lose benefits even though your annual income is less than $17,640.

The earnings limit can lower benefits now, but doesn’t take them away. (This could work for both Maureen and Vanna, assuming again Maureen still has earned income).

The earnings test disappears at full retirement age, meaning you can earn any amount of money without losing SS benefits (I didn’t say, however, that you wouldn’t be paying tax on the benefits). Any benefits forfeited as a result of excess earnings would be restored in the form of higher monthly benefits once you reach full retirement age. For example, if you claimed benefits at 62 and lost 24 months of benefits over the next four years due to the earning test, SS would adjust your monthly benefit at full retirement age as if you had first claimed at age 64, not 62, resulting in a higher benefit going forward.

Observation. Even if you’re still working and may lose SS benefits because you sign up early, it might still make sense to ‘get into the club’ (current recipients) in case the government decides to change the SS system (which they may have to do sooner than later in order to preserve it). This is purely speculation, but I’m willing to bet the government will never attempt to change benefits for current recipients, especially if they wish to stay in office.

You are possibly eligible for three different types of benefits (choose one). (Maureen has had the same spouse since 1985; Vanna was married to her previous spouse for at least 10 years and has not remarried).

1. If you worked and paid SS taxes for more than 10 years, you are eligible for the primary worker’s benefit.
2. If you are married, you may also be eligible for a spousal benefit (but not also a worker’s benefit).
3. If your spouse dies, you may be eligible for a survivor benefit.
4. A divorced spouse qualifies for spousal or survivor benefits if marriage lasted 10 years or more. The following conditions must be met:
   1. You must be currently unmarried.
   2. You must be at least age 62 for spousal benefits or age 60 for survivor benefits.
   3. The ex-spouse needs to be entitled to SS retirement (age 62) or disability benefits. (This is true even if the ex hasn’t filed for benefits.)
   4. You must be divorced for two years to get spousal benefits. However, if the ex is already claiming SS, once the divorced spouse reaches full retirement age the 2-year requirement is waived.

If you qualify for benefits based on more than one ex-spouse or deceased spouse’s records, you can claim benefits based on the ex-spouse’s record that provides the greatest benefit (we’re not talking about Liz Taylor here).

You claiming benefits does not affect your former spouse’s benefit.

Monitor your social security account online

In 2012, SS stopped annual mailings of estimated benefits and went to an online version. Go to ssa.gov and get your account set up. You can monitor projected benefits at various retirement ages, see if there is a missing year of earnings, and receive timely updated information.

Keep informed! While many people feel SS may be going away, others, as we illustrated earlier, will depend on it to provide much of their retirement income. What do I think? Given that I’m just about to leave my 50s, I

think it will still be there. But as I tell my kids, “Please keep working in the private sector and paying those taxes so my generation can suck the system dry!”

(Wouldn’t it be ironic if ‘Marcia Brady’ were to file now and before ‘Jan Brady’ goes to file, the government increases the retirement age??) 

Marcia, while I hope you are happy and still gainfully employed, SS may be a boost to your bottom line right now. Vanna, you might want to defer receiving benefits and keep solving those puzzles! There are certainly many other questions to consider for these two, but hopefully we’ve given you a place to start.

Life is no more than a series of spins of the wheel—we just hope not to land on ‘bankrupt’.

by Tom O’Saben, EA