Finally! The Government Pays YOU!

financial planning for retirement Jan 20, 2020

By Glenn J. Downing, MBA, CFP®

This blog post is actually the first of a trilogy having to do with Social Security.  The second is about the Taxation of Social Security Benefits, and the third is, Will Social Security will be There When I Retire?  

The Social Security benefit program is officially called OASDI – Old Age, Survivor, and Disability Insurance.  As the name suggests, it consists of two parts – the disability income part, and the retirement income part.

Funding for Social Security

The program is funded by payroll taxes under the Federal Insurance Contributions Act (FICA):  7.65% of your gross pay, matched by your employer, on your earnings up to $160,200 in 2023.  This means that, on that same amount, your employer withholds $10,534.05 from your pay, and matches that amount equally.  Technically, the social security amount is 6.2% and the Medicare amount is 1.45%, and these total to 7.65%.  If you earn more than $160,200, then only the 1.45% Medicare tax is withheld on the amount of your pay north of $160,200 – so you sort of get a little raise in your paycheck.  Additional Medicare taxes kick in when you earn above $200,000.  

By law, any excess of revenue that Social Security receives must be loaned to the General Fund of the Treasury.  There is no lockbox, per se.  From the Social Security Administration projects that in 2037 there will be no further surpluses, but will instead need to borrow funds from the Treasury.  This is the underfunding that we read about not infrequently in the news.  I’ll give a few thoughts on that later in this piece.

As with any Federal program, the rules surrounding OASDI are detailed and complex.  My intention here is to provide a good, broad overview.

Coverage Requirements

In order to be covered, one must have 6 quarters of creditable coverage for disability income, and 40 quarters of coverage for retirement income.  The definition of disability is very strict under social security:  you must not be able to perform any gainful work.  There is a 5-month waiting period before benefits are paid (retroactively to filing date), and the disability must have lasted for 12 months or be expected to do so.  After 24 months on social security disability one also qualifies for Medicare benefits, even if well short of age 65.

How the Benefit is Calculated

The retirement benefit is based on the worker’s Primary Insurance Amount (PIA – sort of funny, isn’t it?  I know another use for PIA).  This is a calculation of how much of your earnings will go toward calculating your benefit.  There are three important years to remember:  age 62, NRA (Normal Retirement Age), and age 70.  Your full, or normal benefit, is paid at your NRA.  Years ago NRA was age 65.  Due to financial instability, Congress began phasing in a two-year rise in NRA.  Retirees today have an NRA of somewhere between 65 and 67, and those born in 1960 and later all have an NRA of 67.  If you chose to defer your retirement benefits until age 70, your benefit will increase by 8% per year over your NRA benefit.  So three years of delay can increase a $2000/month benefit to $2519.42/month.

Should you defer your benefit until age 70?  It depends upon the facts and circumstances.  If there is no longevity in your family, and you’ve perhaps had some health issues, I’d say consider getting it while you can enjoy it.  On the other hand, if your parents are in their 90’s and still sharp and enjoying life, I’d say consider delaying.  Basically Social Security reserves a pool of money for you.  If they pay out a larger amount over a shorter period of time – statistically they are paying out the same amount of dollars.  But if you live past the life expectancy tables, that is a good deal for you.

Retirement before NRA

How about early retirement before NRA?  There is a reduced benefit available at age 62.  The reduction in benefit can be calculated without too much difficulty as long as the worker’s PIA is known.  Multiply the PIA by the number of months before age 65 divided by 180.  For example, if my PIA is $2000, and I want to retire at age 64 – 12 months before my NRA, then my calculation is $2000 * 12/180, or $133.33.  My monthly benefit is not the $2000 I’d earn at age 65, but $1866.67.

There’s another important consideration involved in drawing Social Security before NRA, and that is loss of benefits if you keep working.  Once you’ve hit NRA you can draw your full benefit and also earn all you want with no penalty.  But before NRA there are two rules:  the first is that the government will deduct $1 from your benefit check for each $2 you earn above $21,240 (2023).  Consider this example:  if your benefit is $1000/month, and you earn $45,240, the government will withhold 100% of your social security check.  Because you’ve earned $24,000 above the threshold, they hold back ½ of that amount or your entire benefit of $1000/month.

The second rule applies if you draw benefits in the same year that you attain NRA.  In that case, the government withholds $1 for every $3 that you earn above $56,,520 (2023).  Consider carefully the wisdom of early election of social security!  Retirement can easily last 30 years or even longer, and the reduced benefit that may be sufficient now may come up far short in later years.

A separate issue is that the benefit will ultimately be taxable under the provisional income formula – and I’ve written a separate piece about that.

Who can claim benefits?

Who can claim retirement benefits?  The insured retiree, of course.  The retiree’s spouse is entitled to a benefit if over age 62, has a child in care who is under age 16, or has a disabled child in care of any age.

The surviving spouse of a deceased worker can collect that worker’s benefit at age 60.  A divorced spouse, i.e. former spouse, of an injured worker can collect benefits on that worker’s PIA if, over age 62, the marriage lasted at least 10 years, the divorce was more than two years ago, and the former spouse has remained single.

Generally, the spouse will choose between his/her own social security payment or that of the spouse, whichever is higher.

There are also benefits for a surviving spouse who is caring for dependent children.  And yes – there is a death benefit.  $255.00.  You read right.  For some reason, Congress has never indexed this amount.  

 Get in touch! 

Social Security is a big part of retirement planning!  Should you take the benefit early, at your normal retirement age, or wait until age 70?  Feel free to get in touch with us at [email protected].   Also follow us LinkedInFacebookInstagram, and YouTube for more personal financial information relevant to you! 

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