How we got here and where do we go from here?
KEY TAKEAWAYS
Those already collecting benefits, nearing retirement, and younger workers are all groups that might be affected by the proposed changes to Social Security.
You don't want to be behind the eight ball if and when these changes take effect. Stress-test your retirement plans now, so you can be prepared later.
For decades, there has been a sustainability question with Social Security, and it seems we are getting close to our day of reckoning. According to the most recent Social Security trustees’ report, the trust funds that pay retirement and disability benefits will be depleted in just 13 years.
What’s worse is the Social Security Administration (SSA) estimates that, of the more than 46 million Americans receiving Social Security retirement benefits, 50% of married couples and 70% of unmarried people receive 50% or more of their income from Social Security.
While the trust fund becoming depleted doesn’t necessarily mean that benefits would completely stop, there could be a reduction in each beneficiary’s monthly benefit. For someone who relies heavily on Social Security for retirement income, this could have a huge impact.
How did we get here?
Before jumping into the recently proposed changes, I think it’s important to address how we got to this point. There are several fundamental flaws in the system that have contributed to this 80-year Social Security deficit and practically ensured the program would fail.
Unrealistic life expectancies
In 1940, the life expectancy for men and women at age 65 was 11.9 and 13.4 years, respectively. On January 31, 1940, the first monthly retirement check was issued to Ida May Fuller. The SSA formulas were designed on the assumption of providing her with benefits through 1953. Ms. Fuller lived to be 100 and was collecting benefits through 1975 – 22 years longer than the program assumed.
50% Spousal Benefits
Only one spouse may have paid into Social Security, but a non-working spouse will still be eligible for 50% of the working spouse’s benefit.
Spousal Deferral Options
For 80 years, there were loopholes that allowed spouses to collect larger benefits in two ways. The strategies consisted of filing for one benefit while their own benefit or their spouse’s benefit would continue to grow. These loopholes were finally closed in 2015.
Divorced Spouse Benefits
Any number of ex-spouses with a lower benefit is eligible to receive 50% of your benefit if your marriage lasted 10+ years, they remain unmarried, and are 62 or older. So, your current spouse, as well as several past spouses, could be collecting 50% of your benefit, whether they paid into the system or not, and without reducing your benefit.
Survivor Benefits
Upon the passing of the spouse with a larger benefit, the surviving spouse AND qualified divorced spouse(s) would become eligible for 100% of the deceased spouse’s benefit.
What changes are being proposed?
After decades of concern about Social Security funding, lawmakers have recently begun discussions about potential changes needed to restore confidence in this important social program. Like the recent income tax proposals, these changes are in the initial stages and are likely to be altered to some degree, so it’s important to stay informed.
NOTE: All income thresholds mentioned below reflect single filers vs. married filing jointly (MFJ).
Tax more of the benefits
If your combined income (Adjustable Gross Income (AGI) + nontaxable interest + ½ of Social Security benefits) exceeds certain thresholds, your Social Security benefits will be subject to federal income taxes.
Current: Up to 50% of benefits taxable if income is between $25,000 - $34,000/$32,000 - $44,000. Up to 85% of benefits taxable if income exceeds $34,000/$44,000.
Proposed: 50% threshold raised to 85% and the 85% threshold raised to 100%.
Currently, a maximum 85% of a beneficiary’s benefit is subject to taxes. If this proposal is passed, there is a potential that a beneficiary’s entire retirement benefit will be subject to taxes.
For example, if an individual’s monthly retirement benefit is $2,000 and their combined income is $35,000, currently, only 85%, or $1,700, of that benefit is currently taxed. If that threshold is raised to 100%, then all $2,000 of the benefit would be taxable.
While $300/month or $3,600/year might not seem like a lot, for those that are mostly or solely relying on Social Security to meet their spending needs, this could have a significant impact on managing cashflows.
An alternative to this change that is being considered would be to lower the income thresholds mentioned above, which would mean that if your benefits are not currently taxable today, a portion could become taxable, or for some, MORE of their benefit would be taxable.
Increase Social Security payroll taxes
Current: Employers and employees each pay 6.2% of wages up to the taxable maximum wage base of $142,800 (2021); self-employed individuals pay the full 12.4%. That amount goes up to $147,000 in 2022 and is adjusted each year for inflation.
Proposed: Keep the current wage base in place and then reapply the Social Security payroll tax for wages above $400,000.
With this new proposal, you and your employer would pay Social Security tax on earnings up to $142,800, and you would again pay taxes on earnings that exceed $400,000. This essentially creates a donut hole, in which you don’t pay taxes on earnings between $142,800 and $400,000 but, if your earnings are above that amount, then the tax kicks in again. If you earn more than $400,000, any additional taxes paid would not make you eligible for a larger benefit.
This change would put more work on employers to track and administer these tax thresholds. Couple that with the support needed from high-income states like New York and California, there may not be enough political support for a change like this.
There has also been discussion around slightly increasing the 6.2% contribution rate for everyone. While it wouldn’t be increased significantly, with 176 million workers paying into the system every year, even a small increase could have a big impact. We could also envision a scenario where only the employer portion would be increased so that workers don’t carry an increased burden.
Raise the Full Retirement Age (FRA)
Current: If you were born before 1960, your FRA age depends on the year in which you were born. (Ex. If your birthdate is January 1, 1957, your FRA is 66 years and 6 months). The FRA for individuals born in 1960 or later is 67 years old.
Proposed: Raise the FRA to either 68 or 70 years old.
The full retirement age (FRA) is the age at which people can receive full Social Security retirement benefits upon leaving the workforce. There has been some discussion around raising the FRA to either 68 or 70 years old. This is a change that Congress has made in the past, increasing the FRA from 65 to 67 in 1983. Since more and more people are waiting longer to retire and life expectancies continue to rise, this proposal might carry a lot of support.
One thing to consider here would be how the reduced benefit would be affected if an individual filed for Social Security at or after age 62 but before their FRA. Currently, you are eligible to file for Social Security at age 62, but you will receive a lifetime reduction in your benefit. The question is whether increasing the FRA would create a BIGGER reduction in benefits for filing once eligible. This could impact an individual’s decision on when to retire, especially if they will be relying mostly on Social Security benefits to supplement their spending needs in retirement.
How to think about Social Security
While there are still more questions than answers at this point, it is important to proactively stress test your retirement plans now so you have a plan for any changes that may take effect. If you’re younger, while this is unlikely, you can go so far as to assume not receiving anything from Social Security during retirement. If you’re nearing retirement or already collecting benefits, you shouldn’t assume that your benefits are safe. Take the time to review your current cashflows and consider modeling how a potential cut in benefits would affect your financial plan.
Katie Blechschmidt, CFP®
Director of Client Success