Social Security
Students: Social Security is a COMPLICATED topic but worth learning not only for the CFP, but the constant application when helping clients plan for retirement.
Individuals: There is a lot of misinformation out their about social security. Understanding how it works and what its purpose is might make a big difference in your own life!
Advisors/Professionals: Typically advisors are recommending strategies with social security (benefits claiming, taxes, income thresholds, survivor benefits, etc…). Get these right and you can make a HUGE positive impact for your clients!
What is on this page? History of the program. How to read your statement. How a retirement benefit is calculated. Reduction/increase for retiring early/late. Earnings limitations for an early benefit. Taxation in retirement on your benefit.
What is not on this page? Strategies for claiming benefit(s). Details on family maximums and disability, Medicare, and benefits for surviving spouse and/or surviving dependents. Taxation of income/investments to fund FICA.
Social Security - A brief history
Officially starting in 1935 under the direction of President Franklin D Roosevelt, Social Security was platformed as “social insurance” modeled after other countries recently developed plans. At the time, 35 developed countries had similar programs with 20 of those being funded by workers.
Why “social insurance?” I thought it was a retirement plan? Many times the definition gives insight to to the true meaning! INSURANCE - protecting individuals (and their survivors) against risk (of being unable to work). SOCIAL - achieving broader social economic objectives (in this case, providing for those in need and redistributing to those who need it most).
Quotes from Roosevelt
"Security was attained in the earlier days through the interdependence of members of families upon each other and of the families within a small community upon each other. The complexities of great communities and of organized industry make less real these simple means of security. Therefore, we are compelled to employ the active interest of the Nation as a whole through government in order to encourage a greater security for each individual who composes it . . . This seeking for a greater measure of welfare and happiness does not indicate a change in values. It is rather a return to values lost in the course of our economic development and expansion . . ."
Franklin D. Roosevelt: Message of the President to Congress, June 8, 1934.
"We can never insure one hundred percent of the population against one hundred percent of the hazards and vicissitudes of life, but we have tried to frame a law which will give some measure of protection to the average citizen and to his family against the loss of a job and against poverty-ridden old age."--
President Roosevelt upon signing Social Security Act
1935 - the original “Social Security Act” - included benefits for “old age,” unemployment insurance, and aid to dependent children (as well as grants to the states to provide various forms of medical care).
1937 - the Federal Insurance Contributions Act - a trust fund was recreated and the first contributions were collected in 1937 after the Federal Insurance Contributions Act
1939 - amendments made (expanded who is covered) - the original act only protected to worker but in 1939 the amendment added protection for a spouse with minor children (of a deceased worker) and survivor benefits paid to the family in the event of a premature death (IE a “lump sum” death benefit).
1950s/1972 - cost of living increases - it was recognized in the early 1950s that payments were not “keeping up with inflation.” It was voted to increase those currently receiving benefits in September of 1950. Over the next couple decades, it would be voted on at random times to increase benefit but it wasn’t until 1972 legislation that “cost of living allowances” (COLA) were built in to be automatic (based on annual increases in consumer prices) starting in 1975.
1954/56/60 - amendments made (added disability) - disability coverage for workers ages 50-65 was added along with coverage for disabled adult children. Later on in 1960, it was updated to include disability workers of ANY age (and their dependents).
1961 - retirement age lowered - officially changed the “old age benefit” minimum age for eligible men to 62 (women had been given this option since 1956).
1965 - Medicare formerly added - healthcare for those ages 65 and older was signed into law.
1972 - SSI program added (supplemental social insurance) - providing additional income to support to those “needy aged” and “blind individuals” and also added “needy disability individuals.”
1977 - update to funding - this was the first large change to how social security was funded. Realizing a shortfall loomed in the future, they increased the employee tax (from 6.45% to 7.65%), increased the wage base, and reduced benefits slightly. This was anticipated to safely move the program forward another 75 years (though in reality it provided stability for about 50 years - of which we are coming close to the end!). For perspective, they evaluated in 1975 and realized there’d be a “shortfall” in 1979. They made updates in 1977 to make the “minor changes” which righted the program for half a century. (this may help those who appear doomsday over the future of social security)
1983 - update to funding - with dramatic inflation in the 70s, it was realized that additional funding would be needed to keep the future program stable. Social security benefits would now be taxable (for some, based on income), and a future increase in retirement age (from 65 to 67, with those born between 1938 and 1959 having an “in between” full retirement age)
Since the early 1980s, there hasn’t been much change to our social security program! Likely reform will become necessary in the next decade to keep the program solvent for the next few decades.
SSA.GOV - A “brief” history of social security (it is PAGES of great info - the big dates were paraphrased above)
Social Security - Your Statement (how does it work?)
What does social security mean for me!?!? Great question! The easiest way to see “what it means for you” (and your family) is to look at your social security statement!
Statement? They stopped mailing them to me! I haven’t seen one in years! You are right! In 2011, in an effort to save money, the SSA stopped mailing statements. They now only mail to those age 60-65 who haven’t created an online (ssa.gov) account. In 2014, SSA updated to send mailed statements when they reach 25, 30, 35, 40, 45, 50, and 55. (this was then halted in 2017) While saving money, this hasn’t been an overall popular decision as it has been inferred that covered Americans aren’t as informed of their benefits which is a detriment to the program (and individual’s understand of how they’ll receive benefits).
Washington Post article on Social Security Statement mailings
I’m ready to see my statement!! Go to www.ssa.gov and sign up! (or login) Once inside your account, you can view/print/download your most recent statement and find a lot of other helpful details!
SAMPLE STATEMENT FROM SSA.GOV (pictures from this page copied from this sample statement)
I got my statement - now what? Lets figure out how to read your social security statement to understand your benefits!
First page - FULL RETIREMENT AGE amount - at the top your full retirement age (FRA) benefit amount is shown. This is determined based on your age and PIA (more on PIA in a minute).
Second page - benefits detail and your info - you’ll find your retirement age benefits shown at FRA (your full retirement age), as well as 62 and 70. Next you’ll see disability and family survivor benefit info. Note in the family survivors benefits section it mentions a “family maximum.” By ALL of these sections you’ll see a sentence saying if you have “enough credits to qualify for benefits.” Then it lists Medicare and if you are eligible (or not) yet. Lastly, you’ll see your date of birth, estimated taxable yearnings per year after current year (based on last year’s earnings), and the last 4# of your social security #.
Is my benefit calculated with current or future wages and does it factor in future COLA/inflation? You’ll note on page 2 between your birthdate and SS# it mentions “estimated taxable earnings per year after 20XX.” Then underneath in the “what we assumed” paragraph it provides more context. The “estimated future earnings” quoted above is based on your last 1-2 years of earnings history. So if you continued to make EXACTLY what you made in this column (up to your retirement age) then your benefit statement would be completely accurate! Note that most people get inflation/COLA on their wages/income (or if you are younger and expecting raises), this is NOT calculated into your SS benefit as estimated future earnings are based on last year(s) amount! At the same time, for those in their 50s that retire early, your benefit WILL be less as they were estimating you continued to work till 67. You can go on to ssa.gov and use their nifty calculator to plug in more accurate future earnings to recalculate your SS benefit.
Third page - Earnings Record - this is the 2nd to last page (but the last page with personalized detail). You’ll find your earnings history per year that includes a column for taxed Social Security earnings as well as taxed Medicare earnings. These columns may or may not be the same. Typically for higher income earners the SS column is lower than the Medicare column - because SS benefits/tax has a wage limit ($142,800 in 2021 for example). Then at the bottom they summarize what you (and your employer) has paid in to both Social Security and Medicare (this can be shocking to some!).
Calculating your BENEFIT(S)
If you just watched the videos above, you’ll have heard acronyms and phrases such as “FRA” (full retirement age - explained above/below), “PIA” (your Primary Insurance Amount), “AIME” (averaged indexed monthly earnings), and “Bend Points” (formula for calculating your PIA). Lets break down these so you understand how they work!
PIA - Primary Insurance Amount - your PIA is calculated (details below) and is what your retirement, disability, and family survivor benefits are all calculated around.
AIME - Averaged Indexed Monthly Earnings - your PIA (and FRA retirement benefit) is based on a computation using your “AIME.” Social Security looks at your HIGHEST 35 YEARS of "indexed earnings” to compute your future benefits. If you have less than 35 years of past earnings (at retirement), they compute with zeros. If you have working years left to retirement, they estimate your future earnings the same as the last 1-2 years of your earnings (see above). If you have more than 35 years of current (or future estimated) earnings, the system assumes the highest 35 years. To calculate, take these highest 35 years and divide by 420 (or divided by 35 and divide again by 12) to get your AIME! SSA.GOV page for AIME details
That isn’t fair?!?! My earnings from decades ago were SOOO low!! You are correct! The “Earnings Record” (page 3 of your SS statement) includes your past “raw” earnings history. The AIME formula “indexes” (hence the I in AIME) your past earnings to current rates. Once you are over 60, only your earnings from <60 are indexed. There is a new table put out each year, based on your birth year, that you can see the “factors” for multiplying past years to get a “current” number. SSA.GOV page for factors to “index” past earnings to calculate your AIME
Bend Points - bend points is how your PIA (FRA benefit) is calculated! You’ll also see how the system adapts benefits to give proportionately MORE benefit to those that earned less and LESS benefit to those that earned more. Keep in mind - I didn’t say those that earn more get less - the formula weights to “socially redistribute” benefit to provide a needed income base to those with less to keep individuals/families out of poverty (remember - this is “social insurance” - not a retirement plan!). There are three bend points (90%, 32%, 15% - these never change) that are tied to current earnings levels based on the calculated year (these earnings amounts DO change most years). SSA.GOV page for PIA formula and current year Bend Points
PIA formula (bend points) - 2021 formula
(a) 90 percent of the first $996 of AIME, plus
(b) 32 percent of AIME over $996 and through $6,002, plus
(c) 15 percent of AIME over $6,002.
EXAMPLES - lets look at three different calculations so you can understand how the formula applies. We are going to assume a static AIME of $2,000, $4,000, and $10,000 (or the equivalent in today’s dollars of $24,000/yr, $48,000/yr, and $120,000/yr)
$2,000 AIME - 90% of first $996 ($996 x 90% = $896.40), plus 32% of AIME over $996 and through $6,002 (so $2,000 - $996 = $1,004 x 32% = $321.28). Add those two bend point amounts ($896.40 + $321.28) and you have a PIA (and FRA benefit) of $1,217.68.
$4,000 AIME - 90% of first $996 ($996 x 90% = $896.40), plus 32% of AIME over $996 and through $6,002 (so $4,000 - $996 = $3,004 x 32% = $961.28). Add those two bend point amounts ($896.40 + $961.28) and you have a PIA (and FRA benefit) of $1,857.68.
$10,000 AIME - 90% of first $996 ($996 x 90% = $896.40), plus 32% of AIME over $996 and through $6,002 (so $6,002 - $996 = $5,006 x 32% = $1,601.92), plus 15% of AIME over $6,002 ($10,000 - $6,002 = $3,998 x 15% = $599.70). Add those three bend point amounts ($896.40 + $1,601.92 + $599.70) and you have a PIA (and FRA benefit) of $3,098.02.
You can see how those who make more get a higher benefit but it is trimmed to provide those at the bottom with a higher weighted benefit. Keep in mind, there is a FLAT TAX for social security so the person with an AIME of $4,000 paid twice as much tax as the person with an AIME of $2,000 (but their benefit is only about 1.5x larger). The person with an AIME of $10,000 paid in 5x more tax than the $2,000 AIME and 2.5x more tax than the $4,000 AIME (and their benefit is 2.5x larger and 1.65x larger respectively).
When is my Full Retirement Age (FRA)?
Is my benefit taxable?