Adopted in the 1930s, Social Security is known as the Old Age, Survivors and Disability Insurance (OASDI) program. The program was born largely as a result of the Great Depression and was intended as a supplement to retirement savings. The pool of money that these benefits are drawn from is currently being funded by employer and employee payroll taxes (otherwise known as FICA taxes – Federal Insurance Contributions Act).
As we pointed out in our previous post, Social Security Benefits and Timing, helping clients maximize Social Security benefits is an important component to our financial planning process here at Seaside Wealth Management. Benefit eligibility is determined according to whether an individual is fully or currently insured under the system. Most workers are covered under the system, but there are exceptions for those working in some state and local government occupations or railroad workers. There are specific qualifications to become eligible for each of the 4 types of benefits under the Social Security system. The 4 types of benefits are Retirement, Survivors, Dependent and Disability. For the purpose of today’s post, we will focus on retirement benefits.
A worker’s retirement benefit is based on the individual’s Primary Insurance Amount, commonly referred to as PIA. A worker’s PIA is calculated using your average indexed monthly earnings (AIME) which is based on the worker’s lifetime earnings history up to a certain annual limit (currently $132,900 of earnings in 2019). Your full retirement age (FRA) is based on the year you were born. Anyone born before 1938 has a full retirement age of 65 and increases to age 67 for anyone born in 1960 or later. Worker’s can begin to claim benefits as early as age 62 (with a permanent reduction to their benefit) or as late as age 70 (with an approximate 8% increase in benefit for every year you wait beyond FRA).
But, what if a worker is eligible to receive Social Security retirement benefits but wishes to continue to work? The worker could experience a reduction of benefits if they are younger than their full retirement age (FRA). A worker who has attained full retirement age will not experience a reduction in Social Security benefits due to his/her earned income. However, a worker who continues to work and receive Social Security benefits before FRA may find that their benefits are reduced up to 50%. It is important to note that once you reach FRA, you can earn as much as you would like without having a reduction in benefits.
The taxation of benefits can affect anyone receiving Social Security benefits, regardless of age. Here is how that works. First, your provisional income is calculated which includes gross income, tax free interest and ½ of Social Security benefits. If you are married filing jointly and your provisional income is greater than $44,000, up to 85% of your Social Security retirement benefit could be included for Federal income tax purposes. For single taxpayers, the number is $34,000. One thing to note is that distributions from Roth IRAs do not count towards your provisional income! Therefore, Roth conversions before age 70 1/2 can be an effective strategy to reduce your overall tax burden in retirement.
There are two other issues relating to your work that could affect your Social Security benefits. These are the Windfall Elimination Provision (WEP) and Government Pension Offset (GPO):
WEP and GPO are two special elements in the Social Security laws that may serve to reduce a worker’s benefits from Social Security. WEP may apply to a worker who qualifies for Social Security retirement or disability benefits, but who also earns a pension from an employer who did not withhold Social Security taxes. Many government agencies fall into this category. Under this provision, the formula used to calculate a worker’s PIA is reduced, resulting in a lower benefit. The Windfall Elimination Provision does not apply to some survivors benefits under Social Security.
The GPO may apply to Social Security benefits for spouses, widows or widowers. If a worker receives a pension from a federal, state, or local government based on compensation on which Social Security taxes were not paid, benefits for spouses, widows or widowers may be reduced.
Oftentimes we are asked if eligible retirees should count on the existence of their retirement benefit from Social Security. We believe workers contributing to the system today will have a benefit. What may change is the age at which these benefits are available or the cost of living adjustment on future benefits.
We are happy to analyze your benefit options for you. To do this, we will need a copy of your Social Security Statement showing your PIA and past earnings history. You can download your statement on the Social Security website: https://www.ssa.gov/myaccount/.