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Social Security’s Value to Young and Old

Wednesday, April 20, 2016

Two-thirds of Americans over age 65 rely on Social Security (SS) for at least half their monthly income. it’s logical that Baby Boomers and older care a great deal about SS; both how it works and what happens to it.

Millennials – and others near that end of the age spectrum – generally are not at all concerned about SS. Retirement is simply too far over their time horizons. Current challenges can obscure distant ones.

Still, we all hear about SS over and over again. Most accounts are more sound bite than substance. Even the more robust reports tend to generate greater confusion than illumination. With today’s new definition of retirement so very different from sitting on the front porch in a rocker, we all need to know clearly how SS can fit in.*

We like brief. We like clarity. You probably do too. Below are many of the aspects of SS you will want to consider when trying to make the best decision for your particular situation. Choosing the best strategy for you might seem simple. However, ultimately, you have to add several ingredients to your formula to make sure you reach your best answer.

First – What Is Social Security?

SS was established (1935) when our country was recovering from the Great Depression. Many people had lost their jobs, their ability to make a living, and their wealth. There was an alarming economic need for the elderly in particular. To relieve this need, SS was created as a government-run, social insurance program to help older American citizens economically. Though it began as a retirement program, it has since been expanded to provide economic benefits to the disabled, dependent children, and others.

An Important Note

When SS began, the average retirement age was 65. The average life expectancy in 1930 for someone who lived past age 21 (to exclude the high infant mortality rate) was approximately 73. Thus, on average SS had to cover retirees for about 8 years. SS used age 65 for retirement age from then until 2002. Meanwhile our life expectancy grew … and is still growing. SS now has to cover a much longer “retirement” period than it did then. That’s not any different from what we must each do. (Are you listening, Millennials?) Planning to live far longer in retirement needs much more money to do it. It also explains why funding it has meant being older to collect your full benefit.

Next – Who Pays for It?

Look at your pay stub for FICA (Federal Insurance Contributions Act) payroll taxes. Now you know who pays the bills – you do! So does anyone who earns income, unless he or she is in an exempt job. Very few exempt jobs exist today.

Employers match your payment. And the self-employed pay twice! Pretty much everyone in the work force pays into SS. (Those that receive cash income are supposed to claim that income on their taxes. That means also paying FICA. We won’t discuss how well that works.)

How Much Will It Pay You?

Okay. Now you know you’re paying (or paid) for SS benefits. How much isn’t clear. As long as you keep earning, you keep paying. Complicating it further is that the total annual amount you pay changes regularly. So far, that change has only been up. The question is, what will you get back for your payments?

PIA

If you were of full retirement age (FRA) today, here’s how your benefit amount would be determined. It’s based on what’s known as your Primary Insurance Amount (PIA). Your PIA is calculated from your 35 years worked that had the highest earnings, adjusted for inflation. Years worked equal years in which you paid FICA tax and earned work credits. You need to have accumulated at least 40 work credits to be eligible. Most people get these in 10 years (click here for details). If you didn’t pay FICA, you didn’t work as far as your PIA is concerned. If you have fewer than 35 years of earnings history, zeros averaged in for the missing years. In short, your work history determines your eligibility towards benefits. These benefits include not only retirement but also disability and Medicare!

Your PIA is a moving target. If you have higher years with higher earnings than have been used in the calculation, these are substituted for the lower ones used previously.

Your Monthly Check

Your PIA translates into a monthly check. However, the age at which you elect to begin receiving that check also factors into the equation.

We mentioned your FRA above. What does full retirement age mean? It means the age the government determines should be considered as appropriate to retire. Further, it has set various ages as FRA depending on when you were born. Benefits are keyed to how close to your specific age you are when you claim benefits. At your FRA you are deemed to be entitled to “full retirement benefits” – another moving target that creates confusion.

Your FRA is somewhere between 65 and 67 years of age.**  Click here for yours.  (One of the things under discussion to help pay the bill for longer lifespans regularly is increasing these ages again.)

Once PIA & FRA Are Known

Now it’s time to see how the math works. Your PIA as of your FRA gives you the amount of your monthly benefit.

For sake of illustration, let’s use some make believe numbers. Specifically, suppose your FRA is 66 and your PIA at FRA computes to a monthly check of $1,500. That is how much you would get every month if you started taking your benefits at age 66, your FRA. Ignoring any cost of living increases and the time value of money, we can compare how either retiring early or delaying your retirement changes that amount.

In this example, if you began taking your benefit at age 62 (the earliest date you can take them), your benefit would be only $1,125, a 25% reduction.

On the other hand, if you delayed taking your benefit until you turned age 70 (the longest you can delay), your monthly benefit would be $1,980.

Making that contrast a bit more glaring, $1,980 is 76% more than $1,125!

Of course, you have to live to age 80.6 to breakeven on this tradeoff. But from your 7th month of your 80th year, you would be ahead and getting further ahead with each additional month. If you lived to age 90, under the first scenario when you started collecting at 62, you would have collected a total of $243,000. If you had waited until 70, you would have received a total of $475,000.

Last notes on the example, we ignored and cost of living increases and the time value of money for clarity. Additionally, the penalty of starting early or credits for postponing benefits are calculated on your age in years and months. Check out the penalty details here for an early start and here for the bonus you’d get for delaying your benefits for this example. If you want to check your specific numbers, you can do that here.

That is what SS can provide you in basic retirement benefits and when you might be wisest to take them. We hope that you feel more comfortable now than when you began reading this article on SS.

SS provides other benefits, including one for spouses. Click here for more on that one. Other benefits exist for survivors and in case of disability – too complex to describe adequately here in a note. We’ll have to get back to these at another time.

And we’d be remiss if we didn’t say something about SS going broke. After all, you must be hearing that on a regular basis, especially from presidential candidates. Loud debate revolves around keeping the equilibrium between workers paying into the SS Trust Fund and the rate retirees withdraw benefits.

One solution is to increase FICA revenue. FICA revenue could be increased if productivity nationwide increased. Increasing productivity usually increases wages and the FICA tax paid on them. Another solution includes raising taxes by increasing the amount of wages subject to FICA and/or lowering benefits in a number of proposed ways. We pointed out the increasing Full Retirement Age (FRA). This last solution is most popular politically. It’s more palatable to the public to increase the FRA – much easier to delay benefits than to get voters to agree on higher taxes.

Ever wonder if we’re really living longer or how big a factor that might be? The SS’s own actuarial tables have updated life expectancy from age 90 well past age 110. Click here to check yours!

*While you’re pondering your retirement years – regardless of how you picture them – you’ll want to check out all the calculators we have to help you fit some of the pieces together a little more succinctly

**Medicare eligibility is not on this scale. Be SURE to sign up for Medicare at age 65 to avoid costly penalties. Rich made this mistake when it came to the Part D (Drugs) program. He takes no prescription medicine so felt no need to pay for insurance. Then came the headlines of the new immunotherapy and cancer treatment breakthroughs over the last year. With them came information about their prices. Faced with potentially facing costs of over $10,000/month should the need arise, it seemed enrolling might be a prudent move. His premiums are 70% higher than they would have been. Still preferable to potential bankruptcy a long expensive illness could cost but 70% higher than it might have been for this insurance ... and he still takes no prescription medicines!

Don't let this happen to you. Be informed. Many of these questions can be answered using our Longevity/Retirement Simulator. Be sure to read our additional articles (The Retirement Crisis & Who Needs Financial Planning?) too. Stay tuned for more things to keep top-of-mind when making financial decisions regarding SS and otherwise. And give these calculators a go. You never know what ideas they may inspire.

Sources: 10 Steps to Achieve Your Retirement Goals. Eileen Ambrose. AARPBulletin. April, 2015.
Actuarial Life Table. ACTUARIAL STUDY NO. 120. Felicitie C. Bell and Michael L. Miller. web.archive.org. 2011.
Get the Most From SS. Staff. AARPBulletin. April, 2015.
SSA.gov – the Social Security Administration website as of April 12, 2016.
SS Cannot Go Bankrupt, John Harvey. Forbes.com. August 14, 2014.