The Myths of Social Security
For much of the 2000s a popular TV show, Mythbusters, captured the scientific hearts and minds of all ages. The Mythbusters goal; determine what was fact and what was fiction in movies and pop-culture. While we, in the financial advisor community, are much less scientifically savvy, we do still come across myths that need to be busted. On today’s special episode we identify three topics related to Social Security Income and determine if they are busted, plausible, or confirmed!
1) Social Security is going bankrupt in 2033!
This is, unfortunately, a very common misconception and has resulted in many of our clients expressing concern over their ability to continue receiving their Social Security Income (SSI) benefits after 2033. The first step in understanding this program, and busting this myth, is clarifying how it is funded – Payroll Taxes (i.e., FICA Taxes). Social Security is a “pay as you go” system, meaning every year it collects revenue, in the form of FICA taxes, and pays out benefits to beneficiaries from those collected taxes. FICA taxes are comprised of 6.2% paid by the employee on wages earned up to $160,200 (2023 figures), and another 6.2% paid by the employer, for a total percentage tax of 12.4%. What this means, then, is as long as there are people actively working and employed within the U.S. there will be collected taxes to pay for Social Security beneficiary payments.
For many years, dating back to the late 1980s, this program took in more tax dollars than it distributed each year – resulting in a growing trust fund reserve (~$2.8 trillion today). It wasn’t until the early 2010s that we saw this flip, and the trust fund reserve dollars were being used to fill in the deficit gap.
Trust Fund Reserves as a Percentage of Annual Cost
Source: The 2022 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Federal Disability Insurance Trust Funds
It is estimated that the available reserve fund will most likely run dry between 2033 and 2035, as shown in the above figure. As such, many people may wonder what will happen next. Because this is a pay as you go system, tax revenues will still be received and subsequently paid to beneficiaries, albeit at a lower coverage ratio. Instead of receiving 100% of the promised benefit, retirees will instead receive 77% of their promised benefit – which while is certainly not ideal, is a far cry from bankruptcy.
Can anything be done? Yes, absolutely! In fact, there are a number of bills actively circulating throughout congress right now that effect the long-term viability of Social Security to continue paying 100% of its promised benefits. Just within the last 12 months there have been a total of 7 bills introduced to congress that affect the Social Security program in some capacity.
2) You must claim your Social Security benefit at age 62.
While age 62 is certainly the earliest one can file for their Social Security Income (SSI) benefits, it is absolutely not the only age to consider. In fact, a qualifying taxpayer can file for their benefits between the ages of 62 (earliest) and 70 (latest), and the longer you wait, the larger the monthly check. It is your birth year that the Social Security Administration uses to determine when an individual can claim 100% of their benefit (i.e. Full Retirement Benefit or FRA), as calculated by a tax payer’s earning record. For example, taxpayers born in 1960 or later have an FRA of 67, meaning claiming benefits earlier results in a reduction of benefits, up to roughly 30%, if filed at 62. Some may argue that if they claim earlier they will receive up to 5 more years’ worth of dollars put in their pocket – which is certainly true. There are, however, a few additional provisions one should consider before deciding to claim before their FRA.
- Earnings Test: When SSI benefits are turned on, the government will always consider you “retired” even if you may not consider yourself retired. These tests are calculated as follows for tax year 2023:
- If under FRA for the whole year: Every $2 a taxpayer earns over $21,240, $1 of SSI benefits will be deducted.
- In the year you reach FRA: Every $3 a taxpayer earns over $56,520, $1 of SSI benefits will be deducted.
Meaning an American earning more than $48,360, if under FRA, will fully offset any SSI benefits, assuming the average monthly check of a 62-year-old claimant ($1,130/month). If unaware, this simple test can certainly come as a shock for someone who thought they could both claim their SSI early and still work.
- Spousal Benefits: While most everything related to a couple’s financial life typically takes into consideration both spouses, filing for SSI benefits is of particular importance – this is due to the widow(er)’s penalty. This penalty can affect a spouse both in life, and at death.
- In life: Each spouse will be eligible to receive the higher of either their own benefit, or 50% of their filing spouse’s benefit. However, because of the way SSA calculates the spousal benefit, the reduction for an early filing means a spousal benefit is instead reduced by 35%, instead of 30%. See below for a simple example provided by the Social Security Administration:
- At Death: Upon the death of the first spouse, the survivor will only keep one of the two benefits, whichever is higher. As such, the decision to file early, particularly the spouse with the higher earnings history, will permanently reduce the monthly benefit they could leave for their surviving spouse.
3) My Social Security benefits are tax-free!
Unfortunately, this particular myth is one that we all wish didn’t need to be busted. However, there is a silver lining – it may not apply to you. As a quick aside, for some history, Social Security Income (SSI) wasn’t always taxed. When it was originally signed into law by President Roosevelt in 1935, SSI payments received were tax free; meaning at one point this wasn’t a myth!
However, in the early 1980s, America was having very similar conversation as to what we are having today – that Social Security is going bankrupt (a myth we just busted). The way they solved the coverage gap was through a set of amendments that were signed into law by President Ronald Reagan in April of 1983, resulting in some portion of a taxpayer’s SSI payments to be taxed. The resulting surplus revenues were then added to the Trust Fund Reserve. Today, this law still impacts the taxation of an individual’s SSI, but does provide relief for those with lower Combined/Provisional income. The below chart further illustrates how this provisional income is calculated and how much of your SSI will be taxable in a given year.
Important disclaimer: The above is a simplified overview of the calculation and your CPA, or tax software, will be able to specifically provide the true amount of tax due on your SSI, as there are additional tax tests that help refine your true tax figure.
So far, we have only discussed federal taxes and how they apply to one’s SSI – we haven’t yet addressed state taxes. You may be surprised to learn that 42 of the U.S. jurisdictions (including District of Columbia) either do not have state taxes or specifically exclude Social Security from state taxation. Even high tax states such as California, New York, New Jersey, and Oregon do not assess any taxes on SSI.
While we only covered three of the more prominent myths in this article, there are certainly many others that may come to mind or result in questions. Ultimately, understanding the intricacies of Social Security and how it can play an important and thoughtful role as part of your financial plan is difficult – so don’t do it alone! Do know that our team of talented ACM Wealth Advisors have the knowledge and understanding to help you navigate many of these myths. If you have questions, please be comfortable reaching out to your dedicated ACM Wealth Advisor for more information.
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