Chapter 10

Making Your Best Choices under Social Security

IN THIS CHAPTER

Bullet Understanding Social Security retirement benefit calculations

Bullet Determining the best age for you to begin benefits

Bullet Understanding your options for increasing benefits when you’re married (or have been)

Bullet Avoiding lost benefits from working

Bullet Reducing taxes on Social Security benefits

Social Security is one of the least understood components of senior Americans’ personal finances. Traditionally, income during retirement comes from a combination of three sources, often referred to as legs of a three-legged stool. The three legs are employer pensions, personal savings, and Social Security. Many Americans generally take the Social Security leg for granted and don’t give it much thought.

However, this leg is quite important as you attempt to get a firm grasp on your personal finances. Too few people take the time to understand their options and the effects of their decisions about Social Security. And most financial advisors don’t know enough about Social Security retirement benefits.

That’s why we’re here: To help you get a better grasp of how Social Security can affect your finances. This chapter focuses on the important decisions involving Social Security retirement benefits and how you can make them. We explain how benefits are calculated, how to determine the best age at which to begin taking benefits, and how having a spouse may affect that decision. Although the benefits once were tax-free, an increasing number of beneficiaries pay taxes on their benefits each year. So we explain how to minimize income taxes on your Social Security benefits as well. You also can review how working while receiving Social Security benefits may cause your benefits to be reduced.

Furthermore, we examine the financial condition of Social Security. A number of people say they don’t include Social Security benefits in their planning because they don’t expect to receive any benefits. We take a look at the program’s solvency and whether that’s a reasonable way to view Social Security benefits and plan your retirement finances.

Remember Although the Social Security program also offers disability and survivor benefits, this chapter focuses primarily on retirement benefits with some attention paid to the survivor benefits of a spouse.

The Lowdown on Social Security

Most Americans think that Social Security simply is an automatic payment that begins at retirement and that they have little or no influence over the amount of the payment. In truth, Social Security is a fairly broad and complex program that provides retirement, survivor, and disability benefits. Retirement benefits are not automatic. You have to apply for them and choose when they begin, and the choice affects the amount of benefits you receive. The amount of benefits you receive also can depend on your spouse’s benefits. You may even be able to change your mind after starting to receive benefits.

The original intent of Social Security’s retirement benefits was to provide a basic, minimum income for retired workers. The lower your working years’ income was, the greater the percentage of that income Social Security would replace. However, Social Security has undergone some changes, and most employers have eliminated defined benefit pension plans (those that guarantee a fixed monthly retirement payment for life), shifting the risk of saving and investing to employees. As a result, for many people, Social Security retirement benefits are the only source of retirement income that’s both guaranteed and indexed for inflation. It is also a major source of income for many retirees. (Refer to Chapter 1 for more in-depth discussion about this topic.)

Remember When you decide to begin receiving Social Security benefits determines the amount of the benefits. Other issues also decide the amount of your benefits. The key issues that determine the amount of benefits you receive are as follows:

  • The age at which you (and your spouse, if you’re married) begin receiving retirement benefits
  • Whether your benefit payments are based on your work record or your spouse’s
  • Whether you should change from receiving benefits based on your earnings record to benefits based on your spouse’s earnings record, or even change the age at which you begin receiving benefits
  • Whether your marital status changed over the years — which can lead to additional choices

You (and other beneficiaries) have several opportunities to make choices about your retirement benefits, and the choices greatly influence the amount of payments you’ll receive. Because Social Security continues for life, the choices you make can alter lifetime income by tens of thousands of dollars or more. The decisions you make also affect the amount of survivor benefits received by your spouse. Your financial security is enhanced if you search for ways to increase the guaranteed income from Social Security retirement benefits.

Many people believe decisions about Social Security retirement benefits are final, but that’s not the case. You can change your mind and restart benefits in at least two situations. We explore those situations in this chapter. See the sections “Understanding the choices for spousal benefits” and “Ensuring spouses are taken care of: Survivor’s benefits.”

Determining When You’re Eligible for Benefits

You’re eligible for Social Security retirement benefits after earning 40 work credits. You earn a work credit when your earned income, subject to the Social Security tax, exceeds a minimum level. The minimum income level is indexed for inflation and was $1,470 for 2021. You earn up to four credits per year, no matter how much income you earn. Therefore, you’re entitled to retirement benefits if you work a total of at least ten full years during your lifetime in which you earn an amount of income covered by Social Security equal to at least four credits.

After you know you’re eligible to receive benefits, determining the level of benefits you’ll be paid isn’t quite as clear. The benefits are based on the highest 35 years of earnings before beginning benefits. The earnings from prior years are indexed for wage inflation as part of the computation. The result is a figure called average indexed monthly earnings, which is used to determine your benefits. This computation is quite technical, but we cover the essentials here; if you’re interested in more of the fine details, go to the Social Security website (www.ssa.gov).

Remember What you need to know is that, in general, the higher the income you post for your highest 35 years of working, the higher your benefits will be. However, remember that there’s a limit on the amount of income subject to Social Security taxes during your earning years. The benefit computation doesn’t include income earned above that limit.

Even though higher income earners receive more benefits than lower income earners, the benefits for higher income earners replace a smaller proportion of earnings than for lower income earners. In other words, individuals with lower lifetime earnings have a higher replacement ratio than those with higher incomes. The replacement ratio is the percentage of final-year working income that’s paid in retirement benefits. Lower income retirees can receive Social Security benefits equal to about 90 percent of their pre-retirement income. The benefits of high-income retirees are about 15 percent or less of pre-retirement income. The average benefit is about 40 percent of the final working year’s earnings.

So how can you figure out when you can start receiving distributions from Social Security and what the benefits would be at different ages? The following two sections can help you make those determinations. If you’re not at retirement age yet, your first resource is the annual earnings history report you receive from the Social Security Administration (SSA) or can find on the Social Security website. You also need to know what Uncle Sam has defined as the age you can retire to receive your full benefits.

Reviewing your earnings history

The SSA used to send everyone over age 24 with an earnings history an annual statement of estimated benefits a few months before his or her birthday. That practice was stopped as a cost-saving measure in 2011. Since then, the practice has fluctuated with budget constraints.

You can obtain a statement of your earnings online anytime by establishing a personal account at www.ssa.gov/myaccount. SSA is encouraging people to open online accounts and hopes to phase out paper statements and forms. The statement shows the earnings history in Social Security’s records and estimates the retirement benefits that would be received if benefits were to begin at ages 62, 70, and full retirement age (which for most people still working is between ages 66 and 67). Other information and estimates also are included.

Investigate The earnings history in SSA’s records is critical. If the history is incorrect, the benefits eventually paid to you will be incorrect. You have three years to correct an error in a year’s earnings amount. We suggest that you at least review the recent earnings history every couple of years and decide whether it needs to be corrected. If you do need to correct it, you can contact SSA online or call the SSA at 800-772-1213 from 7 a.m. to 7 p.m. every business day. Or you can take your records to your local SSA office. To correct your earnings record, you need to give your name, Social Security number, the year or years that contain erroneous earnings, and the business name and address of your employer in those years. Helpful items to have are your W-2 forms (or tax returns if you’re self-employed) for the incorrect years.

Remember An examination of the earnings history can provide you with useful information to decide what may be a good age for you to retire. Most people have low earnings during the early years of their careers and mostly steadily rising earnings after that. Workers suffering extended layoffs, however, may have low income earning years at other times in their work histories. Remember that the benefits calculation uses only your highest 35 years of earnings, so working a few extra years could remove the lowest earning years from your “high 35” and ultimately increase your Social Security retirement benefits. And keep in mind that an increase in the benefits means a higher payment every month for the rest of your life, so it can amount to a large sum over time.

Defining when you can retire

The federal government has set the benchmark for retirement benefits, called full retirement age (FRA), or normal retirement age. If you begin retirement benefits at this age, you receive full retirement benefits (FRB), also known as normal retirement benefits. Begin benefits earlier, and you receive lower monthly benefits. Delay receiving benefits after FRA, and you receive a higher annual payment.

For many decades FRA was 65. The reforms of 1983 phased in a higher FRA for anyone born after 1937 (anyone who turns 65 after 2002). When fully phased in, the schedule creates a new FRA of 67 for anyone born after 1959. Check out Table 10-1 for a schedule of FRAs to see where you fall.

TABLE 10-1 Age to Receive Full Social Security Benefits

Year of Birth

Full Retirement Age (FRA)

1937 or earlier

65

1938

65 and 2 months

1939

65 and 4 months

1940

65 and 6 months

1941

65 and 8 months

1942

65 and 10 months

1943–1954

66

1955

66 and 2 months

1956

66 and 4 months

1957

66 and 6 months

1958

66 and 8 months

1959

66 and 10 months

1960 and later

67

Note: If you were born on January 1 of any year, you should refer to the previous year. If you qualify for benefits as a survivor, your full retirement age may be different.

 

There’s an annual limit on the amount of retirement benefits, regardless of pre-retirement income. The limit is indexed for inflation. So, for example, someone retiring at full retirement age in 2021 received no more than $3,148 monthly regardless of how high her lifetime earnings were. (For comparison, the average monthly retirement benefit paid in 2021 was $1,543.)

Remember You can begin receiving Social Security retirement benefits as early as age 62, and you don’t have to be retired from work to receive them. You can choose the starting date. However, note that if you begin the benefits before FRA, the amount of benefits will be reduced below the FRB. The benefit is reduced by a percentage for each month you begin benefits before FRA. The amount of the reduction depends on the year of your birth. The reduction in benefits for early retirement is a little complicated. The beneficiary loses math percent of the full benefit for each month of the first 36 months before FRA, and math percent of the full benefit for each additional month before FRA that benefits begin. We discuss this penalty in the later section “Noting How Working Reduces Benefits.” Table 10-2 shows the reduced benefit for taking benefits at 62 for each age group.

TABLE 10-2 Full Retirement and Age 62 Benefit by Year of Birth

Year of Birth

Full (Normal)Retirement Age

Months between Age 62 and Full Retirement Age

A $1,000 Retirement Benefit Would Be Reduced To

The Retirement Benefit Is Reduced By

A $500 Spouse’s Benefit Would Be Reduced To

The Spouse’s Benefit Is Reduced By

1937 or earlier

65

36

$800

20.00%

$375

25.00%

1938

65 and 2 months

38

$791

20.83%

$370

25.83%

1939

65 and 4 months

40

$783

21.67%

$366

26.67%

1940

65 and 6 months

42

$775

22.50%

$362

27.50%

1941

65 and 8 months

44

$766

23.33%

$358

28.33%

1942

65 and 10 months

46

$758

24.17%

$354

29.17%

1943–1954

66

48

$750

25.00%

$350

30.00%

1955

66 and 2 months

50

$741

25.83%

$345

30.83%

1956

66 and 4 months

52

$733

26.67%

$341

31.67%

1957

66 and 6 months

54

$725

27.50%

$337

32.50%

1958

66 and 8 months

56

$716

28.33%

$333

33.33%

1959

66 and 10 months

58

$708

29.17%

$329

34.17%

1960 and later

67

60

$700

30.00%

$325

35.00%

Note: If you were born on January 1, you will be treated as if born the previous year. If you were born on the first of the month, the benefit is figured as if your birthday was in the previous month. You must be at least 62 for the entire month to receive benefits. Percentages are approximate due to rounding. The maximum benefit for the spouse is 50% of the benefit the worker would receive at full retirement age. The % reduction for the spouse should be applied after the automatic 50% reduction. Percentages are approximate due to rounding.

 

The law provides an incentive, known as delayed retirement credits, to delay receiving benefits after FRA. The credits are a rate of increase in your benefits for each month you postpone receiving benefits, and the rate of increase depends on the year you were born. So your age and the number of months you delay receiving benefits determine how much benefits increase when you wait. A third factor is the salary you receive if you continue to work before receiving benefits. Because your highest 35 years of earnings are used to calculate benefits, working more years may increase your FRB if later higher-earning years push lower-earning years out of the top 35. Table 10-3 shows the rate at which FRA increases. There are no increases for delaying benefits past age 70.

TABLE 10-3 How Much Will Delayed Retirement Increase My Benefits?

Year of Birth

Yearly Rate of Increase

Monthly Rate of Increase

1930

4.5%

⅜ of 1%

1931–1932

5.0%

math of 1%

1933–1934

5.5%

math of 1%

1935–1936

6%

½ of 1%

1937–1938

6.5%

math of 1%

1939–1940

7%

math of 1%

1941–1942

7.5%

⅝ of 1%

1943 or later

8%

⅔ of 1%

Taking a Closer Look at Spouses’ and Survivor Benefits

Many seniors consider more than themselves in financial decisions. They also have spouses to be concerned about, and benefits for a spouse are among the least understood aspects of the Social Security program. Here are the two dimensions to incorporating a spouse in decisions on Social Security benefits:

  • A married person receives either spousal benefits based on the other spouse’s earnings record or retirement benefits based on his own work record, whichever results in higher benefits.
  • A surviving spouse can receive either survivor benefits based on the earnings record of the deceased spouse or retirement benefits based on his own work record, whichever results in higher benefits. A surviving spouse can begin receiving one type of benefit and later switch to the other. Keep in mind that the decision of when to begin receiving your own retirement benefits can affect the amount of survivor benefits received by your spouse.

Remember Note the important difference between the spousal benefit and survivor’s benefit: While the higher-earning spouse is alive, the lower-earning spouse’s retirement benefit is half of the higher-earning spouse’s benefit at FRA (or his own retirement benefit, whichever is higher), regardless of when the higher-earning spouse decided to begin benefits. But after the higher-earning spouse passes away, the lower-earning spouse’s survivor benefit is equal to the retirement benefit that the higher-earning spouse was receiving if the deceased spouse already was receiving retirement benefits. The amount of the survivor benefit depends on the age when the higher-earning spouse chose to begin benefits. If the higher-earning spouse began receiving benefits before FRA, the surviving spouse will receive less than the FRB as a survivor benefit, and that reduction will continue for the rest of the surviving spouse’s life.

We explore these dimensions in detail, because the age at which you decide to begin benefits affects the benefits received by a surviving spouse. If you’re not married and have never been married, you can skip this section. We begin with some simple strategies and build to some more sophisticated ones.

Understanding the choices for spousal benefits

One way you can enhance your personal finances as a senior is to take advantage of the spousal benefit. The spousal benefit is the amount of retirement benefits a married person is entitled to based on the earnings record of the other spouse. This benefit is different from the retirement benefit you’re entitled to based on your own earnings history. You may receive either the spousal benefit or the retirement benefit, but not both.

Tip The Social Security Administration is supposed to automatically compare the spousal benefit to the earned retirement benefit and automatically pay the higher of the two. No action is supposed to be required by a beneficiary to receive the higher benefit. But mistakes can be made, so you should know the highest benefit you’re entitled to and be sure that is what you’re receiving. If you aren’t, contact the SSA.

If you’re the lower-earning spouse, you can start receiving spousal benefits when your higher-earning spouse begins receiving retirement benefits. The two of you have some important decisions to make before the lower-earning spouse takes benefits, however. Note: To help you grasp what you and your spouse can do, we assume one spouse has higher lifetime earnings than the other. We refer to the spouses as the higher-earning spouse and the lower-earning spouse.

Remember In general, the spousal benefit is one-half of the benefit at FRA earned by the other spouse, if the lower-earning spouse doesn’t begin receiving benefits until her own FRA or later. However, note that it doesn’t matter whether the higher-earning spouse begins benefits at age 62, age 70, or somewhere in between. The spousal benefit is one-half the benefit that the higher-earning spouse would receive by beginning benefits at FRA. Also, when the lower-earning spouse receives the spousal benefit, it doesn’t affect the amount of benefits received by the higher-earning spouse.

So what choices does the lower-earning income spouse have? The following sections explain your options along with some examples.

Choice No. 1: Lower-earning spouse retires first, takes own benefits

When the higher-earning spouse hasn’t begun receiving retirement benefits, the lower-earning spouse’s only option is to begin receiving retirement benefits based on her earnings history. A spousal benefit can’t begin until the higher-earning spouse actually begins receiving benefits. If the lower-earning spouse wants to begin benefits but the higher-earning spouse is delaying benefits, the lower-earning spouse’s only option at that point is to receive benefits based on her own earnings record. After the higher-earning spouse begins receiving benefits, the lower-earning spouse can shift to the spousal benefit.

Choice No. 2: Higher-earning spouse begins benefits, boosts lower-earning spouse’s benefits

After the higher-earning spouse begins retirement benefits, the lower-earning spouse can receive the higher of the spousal benefit or his own retirement benefit. When the lower-earning spouse already is receiving benefits based on his own earnings history, he switches to the spousal benefit after the higher-earning spouse begins retirement benefits.

When a lower-earning spouse takes benefits based on the higher-earning spouse’s earnings record, the lower-earning spouse receives half of the higher-earning spouse’s FRB, but only if the lower-earning spouse waits until his own FRA to begin any benefits. If the lower-earning spouse decides to begin benefits (whether his own retirement benefit or a spousal benefit) before his own FRA, the spousal benefit will be less than half of the higher-earning spouse’s FRA. The benefit will be reduced on a sliding scale just the same as if the person began receiving his own benefits before FRA. If the lower-earning spouse selects age 62, he will receive a benefit that’s about 35 percent of the higher-earning spouse’s FRA benefit. Because FRA is on a sliding scale, the exact reduction will depend on the lower-earning spouse’s year of birth.

For example, say each spouse is age 62. The lower-earning spouse’s earned retirement benefit is $900 monthly at FRA or $500 at 62. The higher-earning spouse is entitled to $1,900 monthly at FRA. The lower-earning spouse wants to begin receiving benefits now. The higher-earning spouse continues to work and delays benefits. The lower-earning spouse begins receiving $500 at 62. The higher-earning spouse finally begins receiving benefits at FRA of $1,900. The lower-earning spouse now can switch to receive half of the higher-earning spouse’s benefit. Normally the spousal benefit would be $950 (half of the higher-earning spouse’s FRB), but because the lower-earning spouse began receiving benefits at 62, the benefits are reduced by 35 percent. By beginning his own retirement benefits early, the lower-earning spouse permanently reduces monthly benefits, even if he later switches to the spousal benefit.

Remember If the lower-earning spouse begins retirement benefits before FRA based on his earnings record and later shifts to spousal benefits, the spousal benefit will be reduced based on the age at which the lower-earning spouse began receiving the retirement benefits based on his earnings record.

This strategy is no longer available. Now, when someone asks for benefits to be suspended, all benefits paid on that person’s earnings record also are suspended.

Ensuring spouses are taken care of: Survivor’s benefits

If you’re the higher-earning spouse, you want to make sure your lower-earning spouse is taken care of — at least we hope so. In that case, you, the higher-earning spouse, need to consider survivor’s benefits when deciding the age to begin retirement benefits. A Social Security survivor’s benefit is the benefit payable to a surviving spouse after the other spouse passes away. The survivor’s benefit is 100 percent of the benefit the deceased spouse was receiving when the deceased spouse already was receiving benefits. A surviving spouse can begin survivor’s benefits as early as age 60 but will receive a lower benefit. This section identifies some strategies you can use to ensure your spouse receives the maximum benefits after you’re gone.

Remember As the higher-earning spouse, you have to figure out how your decision regarding taking benefits affects your lower-earning spouse. Your goal should be to maximize the lifetime income of your spouse.

Strategy No. 1: Delay retirement benefits

You can increase the lifetime income of your lower-earning spouse if you delay retirement benefits, but only if you, the higher-earning spouse, die first. Delaying benefits is a form of free life insurance that provides extra income to the lower-earning spouse.

Remember When both spouses are alive, the lower-earning spouse can receive the higher amount of his earned benefit or 50 percent of the higher-earning spouse’s benefit at FRA. When the higher-earning spouse dies, the lower-earning spouse can’t receive retirement benefits and a survivor’s benefit. When someone is eligible for both types of benefits, he receives only the higher of the two types of benefits. If the higher-earning spouse passes away, the surviving spouse either continues to receive his own earned benefit or receives 100 percent of the benefit that the higher-earning spouse was receiving before passing away. In other words, when both spouses were receiving benefits and one passes away, the household’s income will be reduced by the lower of the two benefits the spouses were receiving.

The survivor’s benefits rules should influence the age at which a higher-earning spouse decides to begin retirement benefits. For example, say the higher-earning spouse is eligible for $1,800 monthly at FRA, while the lower-earning spouse is eligible for an earned benefit of $700. (Assume both are at FRA.) If the lower-earning spouse chooses to take the spouse’s benefit while the other spouse is still alive, he will receive $900 monthly, half of the higher-earning spouse’s FRA benefit. The amount received by the higher-earning spouse will depend on the age her benefits began. Suppose she delayed benefits past FRA and receives $2,200 monthly. If the higher-earning spouse passes away first, the lower-earning spouse would then receive $2,200 monthly as a survivor’s benefit. If the lower-earning spouse passes away first, the higher-earning spouse continues to receive only her earned benefit. Suppose instead the higher-earning spouse began benefits before FRA and was receiving $1,500 monthly. If the higher-earning spouse passes away first, the surviving spouse will receive $1,500 monthly. (Remember the monthly benefits are indexed for inflation each year. We’re using the amounts without indexing to simplify the example.)

Strategy No. 2: Begin benefits twice

The Social Security law allows married couples to use a strategy we coin “beginning your benefits twice,” which can increase lifetime benefits. With this strategy, a spouse initially begins benefits, either his own earned benefit or a spousal benefit. After a few years, he switches to the other benefit. The strategy can maximize lifetime benefits, depending on which spouse earned more income and when each begins receiving earned retirement benefits.

For instance, consider the example in the earlier section “Understanding the choices for spousal benefits,” where the lower-earning spouse began benefits based on his own earnings record because the higher-earning spouse hadn’t yet begun receiving benefits. After the higher-earning spouse began benefits, the lower-earning spouse switched to spousal benefits based on the higher-earning spouse’s earned benefit at FRA. In this case, the lower-earning spouse began benefits twice.

There are limits to the “beginning your benefits twice” strategy. Under recent rules changes, when you apply for a Social Security benefit, you are deemed to have applied for all benefits for which you are eligible and will be paid the higher of the benefits. (The only exception is for a surviving spouse.) The lower-earning spouse can claim only retirement benefits, because the higher-earning spouse hasn’t yet applied for retirement benefits. At that point the lower-earning spouse isn’t eligible for spousal benefits. After the higher-earning spouse applies for retirement benefits, the lower-earning spouse will be paid the spousal benefits.

Remember Only one spouse at a time can receive spousal benefits. One spouse must have filed for retirement benefits for the other to be receiving spousal benefits.

Identifying When You May Need to Receive Benefits

Social Security is an asset. It’s a stream of income the government owes you. Like any asset, you need to manage Social Security in order to maximize lifetime income in a way that’s consistent with your other goals and needs. When considering the time to begin drawing benefits, answer the questions in the following sections.

We address both a case of an individual deciding when to take benefits and also a case when a spouse is involved. The situation with a couple is a little more complicated. The couple can decide either to maximize lifetime benefits or to ensure that the lower-earning spouse receives the highest possible benefits if he survives the other spouse.

What are your cash flow needs?

If you need access to your benefits to pay expenses before you’re eligible for full benefits, you probably have no choice but to begin receiving benefits early. If you’ve left the workforce — whether through choice or circumstances — you may have limited sources of income. You may need to begin Social Security retirement benefits in order to pay living expenses as early as 62. Someone who still is in the workforce but on a part-time basis or at a reduced income also may need to begin benefits to meet expenses. If, however, you can continue to work and have investments or pensions that generate enough income to support your standard of living, you can afford to hold off on receiving benefits until your FRA or later.

Will waiting pay off?

When you don’t have immediate need for retirement benefits before FRA, you may want to receive benefits based on the age that will generate the largest lifetime income. You can estimate this age by considering a simple trade-off: Begin retirement benefits early and you receive benefits for a longer period of time. Delay benefits and you receive a higher benefit. At some point, waiting to receive the large benefit is worthwhile.

So how do you know really when you’ve reached this point? A simple way to decide is to calculate the rough break-even point. The break-even point is the year when the total lifetime benefits received from beginning benefits at a time other than FRA equals the benefits that would be received from beginning benefits at FRA.

For example, say your benefit at FRA (age 66) is $1,400 per month. If you start benefits at 62, the benefit is reduced by 25 percent to $1,050, or $350 less per month. But you receive the benefits for an extra 48 months. The total benefits received between 62 and FRA would be $50,400. Divide that by $350, and the result is 144. That’s the number of months you would have to live beyond FRA to receive the same lifetime benefits as would be received by starting benefits at age 62. If you divide 144 by 12, you get 12 years. You would have to live to age 78 to reach the break-even point. If you live longer than the break-even point age of 78, you would come out ahead by $350 for each additional month lived by waiting to receive benefits.

Now, consider yourself in the same position but drawing benefits later. The benefit at age 70 would be $1,820 monthly, or 130 percent of the FRA benefit. Beginning benefits at 66 means receiving benefits for 48 extra months for a total of $67,200 of benefits received by age 70. Waiting until age 70 would result in an extra $420 per month. Divide the total benefits that would be received between ages 66 and 70 by the extra amount received by waiting until age 70. The result is 160. So it would take 160 months after age 70 for the lifetime payments received by beginning benefits at 70 to equal those received by beginning benefits at 66. If you divide 160 by 12, the result is 13.33 years. That means you would have to live another 13.33 years (until age 83 and a third) to reach the break-even point of receiving the same amount of lifetime benefits. If you live longer than 13.33 years, the lifetime benefits are higher by waiting.

After you calculate the break-even point, review the later section, “What’s your life expectancy?” Doing so can give you a good idea of the probability you’ll reach the break-even point should you choose to delay benefits.

Remember In either of the preceding cases, you come out ahead by waiting to receive benefits if you live past the break-even point. If you pass away earlier, your lifetime benefits would be higher by taking benefits early.

The break-even calculation is very simple. It can be made more complicated and precise by considering alternative uses of money and investment options as we discuss briefly in the next section.

What other income do you have?

If you have an investment portfolio or other income capable of paying living expenses, you have discretion over when to begin Social Security retirement benefits. By beginning benefits early you have the option of leaving money invested instead of taking it out to pay expenses. Or you can invest the Social Security benefits as received and continue spending the other sources of income.

Under either scenario you have an investment side fund that compounds until it’s needed. You can assume an after-tax rate of return on this fund and estimate whether the fund would compound enough to justify taking lower benefits early instead of waiting for the higher benefits. If your side investment fund does well, the break-even point from waiting to begin benefits is pushed further into the future. (Refer to the preceding section “Will waiting pay off?” for more on break-even points.)

Warning The problem with considering the results of an investing side fund is the uncertainty of investment returns. You can’t assume a long-term average rate of return, because you won’t be investing for the long term. The projections of how well the side fund would perform would depend on your assumptions about investment returns and taxes. The delayed retirement credits from taking Social Security benefits later, on the other hand, are guaranteed. This area is where consulting with your accountant or financial planner can be helpful.

Do you want to continue to work?

Another factor to consider is any penalty for earned income received while receiving Social Security benefits. If you won’t be working when receiving benefits, this isn’t an issue for you. It also isn’t an issue after FRA. But if you plan to work full- or part-time before FRA, you may earn so much that your benefits are reduced. In that case, it may not make sense to begin receiving benefits before FRA or until you stop working. Check out the section “Noting How Working Reduces Benefits,” later in this chapter, for more details.

What are the potential income taxes on benefits?

You need to consider income taxes when deciding your beginning date for benefits. The general rule is that Social Security benefits are excluded from gross income when computing federal income taxes. But as income rises, a portion of the benefits may be included in your gross income. If your income is high enough to trigger taxes on the benefits after 62 but the income is likely to decline later, it may make sense to delay benefits until a smaller portion of them are taxed. Refer to the later section “Being Aware of Potential Income Taxes on Your Benefits” for more info on the income taxation of Social Security benefits.

What’s your life expectancy?

The key to choosing the best date to begin Social Security retirement benefits is by estimating how long you’ll live. The benefit levels for different ages were calculated so a person who lives to life expectancy receives the same lifetime benefits regardless of when the benefits were begun. Life expectancy for an age group means half the people in the group will live longer and half will live shorter lives.

Of course, you don’t have a crystal ball you can rub to tell how long you will live (and you may not want to know either). But here are a couple factors you can keep in mind when considering the issue:

  • Your personal health: If you have a strong probability of living less than life expectancy (for example you know that you have a chronic disease that will shorten your life), receiving benefits as early as possible makes sense. Otherwise, you may want to assume you’ll be in the group that lives to life expectancy or longer.
  • Your family history: If your family has a history of long life spans and you’re in good health, you may consider delaying benefits to maximize lifetime payments.

Tip The good news for you: The schedule used for determining life expectancies is outdated, and life expectancies have increased. About half of men turning age 65 today will live beyond age 85. More than half of women age 65 today will live beyond 85. The bonus for delaying benefits probably is higher than it should be under current life expectancies. So more than half of an age group is likely to live beyond the life expectancy used in the benefit calculations, and more people will benefit from delaying benefits. Of course, if personal or family history raises doubts about living to life expectancy, you should consider taking benefits early.

Noting How Working Reduces Benefits

If you receive Social Security retirement benefits from age 62 to your FRA, you face a limit on the amount of income you can earn while receiving those benefits. The limit and amount of the penalty for earning more than the limit depend on your age. You can check out the limits on the Social Security Administration website at www.ssa.gov. Note: The limit is applied monthly and applies until you reach FRA.

Earned income is income from a job or self-employment. It includes most sources of income from providing personal services or selling goods or services. Earned income doesn’t include investment income and passive income such as interest, dividends, capital gains, pensions, and IRA distributions. Self-employment income is net self-employment income, which is gross income from the business minus business-related expenses.

Taking the penalty for exceeding the annual income limit

If you’re still working, you tell the SSA before the start of each year how much income you expect to earn for the year. When your estimated income will exceed the earned income limit, the SSA then computes the penalty and withholds the appropriate amount from your benefits check each month. If your earned income changes in either direction, you must notify the SSA so it can adjust the withholding.

Between age 62 and the year FRA will be reached, benefits are reduced $1 for every $2 earned over the limit. The limit was $18,960 for 2021 and is indexed for inflation each year. For example, 62-year-old Sally is due $7,200 in benefits, but because she’s earning $40,000 in 2021, she would lose all Social Security benefits for the year. If Sally actually earned only $20,000 that year, $520 of her benefits would be withheld. (The income of $20,000 minus the limit of $18,960 shows an excess income of $1,040. Divide the excess by two, and she loses $520 of benefits.) The SSA would withhold her January benefit. The $600 monthly benefits would be paid February through December. In January 2022, Sally would be paid the extra $520 that was withheld in January 2021.

In the year you reach FRA, retirement benefits are reduced $1 for every $3 earned over a dollar limit. The limit, which is indexed for inflation, is $50,520 in 2021. The limit applies on a monthly basis until the month you reach FRA. Beginning with that month, full retirement benefits are received no matter how much income is earned.

For example, say that Bobby Beneficiary hasn’t yet met FRA at the beginning of 2021, but he reaches it in November 2021. The retirement benefits are $600 per month, or $7,200 for the year. Bobby earned $55,000 in the 10 months from January through October. The SSA would withhold $1,493 ($1 for every $3 earned above the $50,5200 limit). To implement the limit, the SSA would withhold the January through March checks of $600. Beginning in April 2021, Bobby would receive the $600 benefit monthly, and this amount would be paid each month for the remainder of the year. The SSA would pay Bobby the remaining $307 from his March 2021 check in January 2022.

Determining the penalty on a monthly basis

When someone begins Social Security benefits during a calendar year (versus at the beginning of the year), income earned before the benefit beginning date doesn’t count in applying the penalty. Instead, the annual earnings limit is computed on a monthly basis, and only the monthly earnings after the date retirement benefits begin count toward the penalty. For example, in 2021 the monthly earnings limit for someone younger than FRA is $1,580 ($18,960 divided by 12).

For example, imagine a man begins retirement benefits at age 62 on October 30, 2021. He had $45,000 of earned income through October. He leaves that job and takes a part-time job beginning in November earning $500 per month. His earnings for the year substantially exceed the limit of $18,960, but only the monthly earnings after October count. Because each month after October he will earn less than $1,580, he won’t experience any reduction in benefits in November and December. Beginning in 2022, only the annual limit will apply for this beneficiary if he continues to work the entire year.

Remember Special rules apply to the self-employed. In addition to the net income, the SSA looks at the amount of time spent on the business. In general, if someone works more than 45 hours a month in self-employment, that person isn’t considered retired and will lose all or some of her benefits. Someone who is self-employed and works less than 15 hours a month is retired and faces no penalty. Someone who is self-employed and works between 15 and 45 hours a month isn’t considered retired if the job requires a lot of skill or the person is managing a sizeable business.

The penalty isn’t always bad

The loss of benefits from the earned income limit isn’t permanent. After FRA is reached, benefits will be recomputed to give you credit for the lost benefits. But credit is allowed only for the months when the entire benefit was withheld.

Continuing to work may actually increase your benefits after FRA. Your highest-earning 35 years will be used to determine the benefits. Each year the SSA reviews the records of beneficiaries who receive earned income. If the most recent year is one of the top 35 earnings years, the benefits are automatically recalculated. The higher benefit should begin in December of the year after the earnings year. For example, suppose your 2020 earnings would result in a recalculation of benefits during 2021. The additional benefits would be retroactive to January 2021 and would be paid in a lump sum in December 2021.

Preserving Your Benefits

You may be able to plan and manage your income to avoid losing Social Security retirement benefits before reaching FRA. But you also need to be wary of any strategies that people suggest because if the Social Security Administration doesn’t like what it sees, your strategy could be a mistake that costs you money. If someone recommends a strategy to you, check it out with a knowledgeable, objective advisor or contact the SSA. The good news: We’re on your side, and in this section we look at a few ways you may be able to earn some income legally without having your Social Security retirement benefits reduced.

Tip The rules for earned income have many nuances and technical terms and a lot of misinformation and fraudulent strategies, sometimes recommended by unscrupulous individuals, are floating around. So if your earned income and Social Security benefits are high enough to merit the investment, before choosing a strategy, get the advice of an attorney, accountant, or financial advisor who’s familiar with the rules.

Deferring income

One strategy you may be able to take to preserve your Social Security retirement benefits is to defer some of your income. Income deferral means you perform services this year but payment for the services is not due until a future year. The classic case of income deferral is a pension. You work for 30 years or more and part of your earnings are not paid until you retire. Income can be deferred for shorter periods, even from one year to the next, and you can defer income outside of a retirement plan.

Remember In most cases, earned income is applied against the limit in the year it’s earned, not in the year it’s paid. So you can’t avoid the earnings limit simply by agreeing to have your employer pay it in a future year. If you have the legal right to receive the income, it must be included in your earned income for Social Security purposes in the year you earned it.

Here are a couple options to defer your income that help you avoid the earned income limit:

  • Defer it under a retirement plan in which employer contributions aren’t vested. If you work and employer contributions are paid into a retirement plan but aren’t vested, the employer contributions aren’t considered earned income. They haven’t been paid to you, and you don’t have a legal right to them yet.

    Warning However, the earnings limit applies if you work and earn retirement benefits that are vested or not at risk of forfeiture. Also, although the money deferred may avoid federal income taxes this year, it’s included in earned income to determine the earned income limit.

  • Defer it under a nonqualified deferred compensation plan. This type of plan is a contract between you and your employer. To avoid having the money considered earned income for the year, there must be a risk that you would lose or forfeit the money before receiving it. The money can’t be payable to the employee until the future. The employer can’t place the money in a trust for the worker’s benefit or purchase an annuity in the employee’s name. If the employer goes bankrupt, the employee must have the status of a general creditor with no secured interest in an asset that would pay the income.

    Warning The rules are complicated, and an experienced lawyer should be used to draft the agreement. The expense and trouble may not be worth the amount of benefits at stake.

Using your corporation

If you own a business through a corporation, you may be able to use the corporation to avoid the earned income limit on Social Security benefits. You set your salary so it’s under the earned income limit.

Warning Be careful. There’s a right way and a wrong way to do this, and corporate owners often get caught doing it the wrong way. You really shouldn’t try to use this strategy without the advice of a tax expert who knows this area of the law. You can’t simply cut your salary the year Social Security benefits begin, especially if you take the same amount of cash out of the business through dividends and other distributions that don’t qualify as salary or bonus. Both the IRS and the SSA state a salary must be reasonable in light of the work done and qualifications of the employee. If the salary is set at an artificially low level, the SSA considers it fraud. Both the IRS and SSA have litigated and won cases against corporate owners who set unreasonably low salaries to avoid either payroll taxes or the earned income limit.

Tip To successfully avoid the earned income limit, you have to establish the new salary as reasonable for the work done and your level of expertise. If your salary declines sharply the year benefits begin, your hours worked also should change. The corporate minutes should document why the salary level is reasonable. Some advisors believe you also should transfer voting control of the corporation or set up an independent board or committee that sets the salary.

Considering exempt income

When trying to preserve your Social Security benefits, you may want to take a closer look at ways to earn exempt income. Exempt income is income that doesn’t count toward the earnings limit. As a general rule, compensation that’s tax-free under the tax code isn’t counted as wages or earned income for purposes of the Social Security earnings limit.

For example, you may be able to work with your employer to maximize medical expense coverage and other tax-free benefits and minimize cash compensation. Your employer, for example, may be able to restructure things so it pays more of your insurance premiums and out-of-pocket expenses. These generally are exempt income. In return, the employer reduces your cash compensation. You should check with the SSA to verify that a form of compensation doesn’t count toward the earnings limit.

Relying on special income

To preserve your Social Security benefits, you can rely on other types of income that are taxable but that the SSA doesn’t consider earned income. Examples of special income include the following:

  • Employer reimbursements for travel or moving expenses
  • Jury duty pay
  • Lottery and prize winnings
  • Pension and IRA distributions
  • Rental income
  • Unemployment compensation
  • Worker’s compensation

More details about how different payments are classified are available in the Social Security Handbook (free from local SSA offices), on the SSA website, and through the SSA telephone assistance hotline at 800-772-1213.

Being Aware of Potential Income Taxes on Your Benefits

Originally Social Security retirement benefits were exempt from federal income taxes. However, in 1986, Congress made some benefits subject to income taxes. In 1993, more of the benefits paid to higher-income beneficiaries became subject to federal income taxes. The result is that the marginal tax rate (the tax rate on the last dollar of income earned) for some Social Security beneficiaries can be 70 percent or higher. Lower-income beneficiaries still receive all their benefits tax-free, but higher-income beneficiaries can have up to 85 percent of benefits included in gross income.

As a result, you need to know when your Social Security retirement benefits may be subject to income taxes. This section explains how the taxes are calculated on your benefits and what you can do to lower yours.

Understanding how modified adjusted gross income works

The level of taxation of Social Security benefits depends on your modified adjusted gross income, or MAGI. MAGI is adjusted gross income (AGI) from your income tax return (before considering taxable Social Security benefits) plus one-half of your Social Security benefits and some types of exempt income (such as interest from tax-exempt bonds).

Your AGI is the amount left after subtracting from gross income deductions such as IRA contributions, self-employed health insurance premiums, and a few other expenses. Itemized expenses (such as mortgage interest and charitable contributions) and the standard deduction aren’t subtracted to arrive at AGI. (Tip: You can find your AGI on Line 11 on the 2020 version of Form 1040.)

The main type of excluded income that’s added back is tax-exempt interest income. This type of income is interest earned on debt issued by states and localities. Other types of exempt income to add back are interest from qualified U.S. savings bonds, employer-provided adoption benefits, foreign-earned income or foreign housing assistance, and income earned by bona fide residents of American Samoa or Puerto Rico.

So if you’re married and filing a joint return, Social Security benefits are taxed as follows:

  • Up to 50 percent of benefits are included in gross income when MAGI is between $32,000 and $44,000.
  • Up to 85 percent of benefits are included in gross income when MAGI is more than $44,000.

If you’re unmarried, Social Security benefits are taxed as follows:

  • Up to 50 percent of benefits are included in gross income when MAGI is between $25,000 and $34,000.
  • Up to 85 percent of benefits are included in gross income when MAGI is more than $34,000.

Benefits are included in gross income on a sliding scale. In other words, if you’re married and filing jointly and your MAGI is $33,000, you don’t include a full 50 percent of benefits in gross income. You include a portion of the benefits in income, but 50 percent of benefits isn’t included in gross income until your MAGI equals $44,000.

Remember Unlike other parts of the tax code and Social Security, the levels at which Social Security benefits are taxable aren’t indexed for inflation. That means more and more people are paying taxes on their Social Security benefits each year.

Tip IRS Publication 915, “Social Security and Equivalent Railroad Retirement Benefits,” contains details about the taxation of benefits. It also has examples and worksheets to help you estimate the amount of benefits that are taxable. The publication is available free on the IRS website (www.irs.gov).

Warning The SSA doesn’t withhold income taxes on your benefits unless you request it. You must make quarterly estimated tax payments to avoid incurring a penalty for underpayment of estimated taxes. You can find details of how much to pay and how to pay estimated taxes in Publication 505, “Tax Withholding and Estimated Tax,” which also is available free on the IRS website. However, if you’re taking IRA distributions or receiving a pension, you can request that the payor withhold income taxes. If enough is withheld, you’ll avoid penalties for underpayment of income taxes without having to make quarterly estimated tax payments.

You also need to check with your state Department of Taxation or your tax advisor about how your state taxes Social Security benefits. Some states completely exempt Social Security benefits. Others piggyback on the federal system or tax the benefits at a different rate.

Reducing taxes on benefits

If your MAGI is in the range at which some of your benefits will be included in gross income, you may be able to take steps to reduce the taxes on your benefits.

Remember Be careful: You may encounter financial gurus and other people recommending strategies that don’t comply with the tax law. If you’re advised to use a strategy not recommended here, you should have it verified by an objective, experienced tax advisor.

For a married couple, the amount of benefits included in gross income is determined by the joint MAGI. The tax on benefits isn’t avoided or reduced by filing separate returns. In fact, for married couples filing separately, the benefits will be included in gross income when MAGI exceeds $0. On a joint return, it’s the joint MAGI that determines the level of benefits taxed. The taxes aren’t computed separately on the benefits of each spouse. The joint income can cause benefits to be taxed even if only one spouse is receiving them.

Warning If MAGI is significantly above the threshold at which benefits are taxed, planning strategies probably won’t reduce the amount of benefits included in gross income. The changes would have to dramatically reduce MAGI to bring it close to or below the threshold.

Strategies to reduce taxes on your benefits

Almost all regular tax planning strategies that reduce MAGI can be used to reduce the amount of benefits included in gross income. These strategies include reducing gross income and increasing deductions for AGI. Remember that increasing itemized deductions, such as mortgage interest and charitable contributions, doesn’t reduce MAGI. Here are strategies that are most likely to be valuable to you when reducing the taxes on your benefits:

  • Minimize distributions from traditional IRAs, pensions, and annuities. Don’t take money from one of these vehicles unless you need it. Every dollar distributed to you is included in gross income and AGI. Consider tapping other sources, such as taxable investment accounts first. If you have scheduled regular distributions from one of these vehicles, determine whether you can reduce the distributions. After age 72, when required minimum distributions from IRAs and pensions are imposed, this strategy is more difficult. Before then, limiting distributions to those needed to pay expenses may reduce the amount of benefits that are taxed. (Note: Distributions from Roth IRAs and other Roth accounts aren’t included in gross income.)
  • Change investment strategies in taxable accounts to minimize gross income. Reduce trading in the account so capital gains are recognized less frequently. When gains are realized, sell investments in which you have losses to offset the gains. If the accounts hold mutual funds that frequently have high annual distributions, consider switching to funds with lower distributions.
  • Consider using taxable accounts to purchase deferred annuities. Income earned within an annuity is tax deferred; it won’t increase MAGI as long as it remains in the annuity. In addition, annuities aren’t subject to the required minimum distribution rules. For more information on annuities, see Chapter 7.

    Warning This strategy probably isn’t worth using simply to avoid taxes on benefits. You need to consider a wide range of issues (such as whether an annuity fits with the rest of your portfolio and helps you meet your investment goals) before deciding an annuity is appropriate for you. Furthermore, if you do decide to go this route, many different types of annuities are available, so make sure you know what you’re getting.

  • Switch from taxable bonds to tax-exempt bonds. This move doesn’t directly reduce the amount of Social Security benefits that are taxed. Tax-exempt interest is added back to AGI to reach MAGI. But the switch may indirectly reduce the tax on benefits, because tax-exempt bonds usually, though not always, pay lower interest rates than taxable bonds. When the tax-exempt interest is added back to AGI, it results in a lower MAGI than if the investments still were in higher-yielding taxable bonds.
  • Shift income to family members other than your spouse. You don’t want to shift assets that are needed to maintain your standard of living. But when assets and the income from them exceed your needs, consider transferring income-producing investments to other family members. This transferring should be done only as part of a comprehensive estate planning strategy with the reduction in taxes on Social Security benefits a side advantage.

Reducing your MAGI: Deduction strategies

The list in the preceding section includes ways you can reduce income and reduce MAGI. You also can take some deductions from gross income that can reduce MAGI. Even though itemized deductions (such as mortgage interest and charitable contributions) don’t reduce taxes on Social Security benefits, the following deduction strategies may help:

  • Sell capital assets that have paper losses. Many investors don’t like to sell losing investments because the sale locks in the losses. A capital loss, however, can be used to your advantage. One advantage is that the loss reduces MAGI and therefore the amount of Social Security benefits included in gross income. Capital losses first are deducted against capital gains dollar for dollar. Each dollar of loss offsets a dollar of gains and reduces MAGI by a dollar. If the losses exceed the gains for the year, up to $3,000 of the losses are deducted against ordinary income. If you still have excess losses, they’re carried forward to be used in future years in the same way.
  • Examine your portfolio for investments with paper losses. Sell those investments and make the losses deductible. If you still like the long-term prospects for the investments, you can repurchase them. If they’re securities (stocks, bonds, mutual funds), you have to wait more than 30 days to repurchase the same or substantially identical investments. If you don’t wait, the loss deductions are deferred. If you don’t want to wait to be back in the market, you can purchase investments that are similar but not substantially identical.
  • Look for deductions for business losses. Eligible losses include those from partnerships, S corporations, and proprietorships. It may be possible to turn a hobby into a business that generates deductible losses. The losses are deductible if a profit is made in at least any three out of the last five consecutive years. The losses also can be deducted if the operation never earns a profit but is managed in a professional manner with the intention of making a profit. Remember: The rules for deducting business losses can be complicated, so you want to study the rules or receive qualified advice before deducting them.

Changing Your Mind: A Do-Over

Social Security benefit decisions generally are permanent, but some exceptions do exist. For example, a spouse can switch from retirement benefits to spousal benefits under some circumstances. You also can switch to survivor’s benefits after a spouse dies.

Finally, you can change your mind with your Social Security benefits in one other way — when you realize you may have made a mistake. Suppose you already are receiving Social Security retirement benefits and decide you should have waited to a later age to begin benefits. Believe it or not, you may get a “do-over.” You may be able to change the beginning date of your benefits.

Unfortunately, SSA greatly restricted the availability of the do-over. You used to be able to implement a do-over at any time. Now, the do-over is allowed only within 12 months after you begin receiving retirement benefits.

Deciding whether you should take a do-over

So how do you know whether you should consider changing your benefits with a do-over? You may find yourself in one of the following situations:

  • You elected to receive benefits without much thought and then realized you didn’t need them. This scenario is probably the most typical. You then believe your spouse would be better off if your benefits had a later starting date. You have enough in your investment portfolio to repay the benefits. At this time you may decide to file the do-over and pay back the benefits.
  • Changed circumstances or a fresh review indicate later benefits are better. You thought you would need the benefits to meet expenses, but your cash flow changes. You might receive an inheritance or an unexpected job offer.

Doing the do-over

To complete a Social Security do-over, just follow these steps:

  1. Complete Social Security Form 521, “Request for Withdrawal of Application.”

    Filling out this form is simple. You can find a copy of the form at any Social Security office or online at www.ssa.gov.

  2. Submit the form with repayment of all the benefits paid to date.

    Repaying may seem like a stiff price for a change, but keep in mind that no interest is charged. You return only the amount received. In return, after repaying the benefits you can change the start date of your benefits so you receive higher benefits every month for the rest of your life. Your spouse may receive higher survivor’s benefits as well.

Looking at What the Future Holds for Social Security

Each year, usually in April or May, the trustees of Social Security and Medicare issue reports on the financial status of the programs. The financial status described in the reports has worsened over the years. As the Baby Boom generation approaches normal retirement age (the first Boomers turned 65 in 2011), the financial strain on the system is expected to increase because the Boomers aren’t being replaced in the workforce at the same rate they’re expected to retire.

The 2020 report stated that the program’s costs exceed tax revenue and interest earnings each year, and the system is redeeming the Treasury bonds in the trust fund. The trust fund reserves were estimated to be depleted in 2034. Although this may paint an unhappy picture, it doesn’t mean you should write off Social Security and assume no benefits will be available to you. If you’re already a senior, the government is likely to find a way to pay you the full benefits you expected. It would be difficult politically to reduce promised benefits to a large, financially vulnerable and politically powerful part of the population.

Most people overlook one positive factor from the report. Each year the trustees estimate that annual Social Security tax revenues will finance about 75 percent of scheduled benefits almost indefinitely. This means Social Security will be able to pay most of the promised benefits for many years. Congress will make changes, but those changes won’t include a complete cessation or dramatic reduction of benefits. Rather than eliminating Social Security retirement benefits, Congress is likely to take a combination of the following actions:

  • Further means-testing of benefits: Benefits may be reduced or eliminated for higher-income seniors. Another form of means-testing is to include more Social Security benefits in gross income. What’s unknown at this point is the income level at which means-testing may be imposed.
  • A change in the replacement ratio: The replacement ratio is the percentage of your working years’ income received in Social Security benefits. For example, someone earning less than $20,000 now is likely to receive Social Security benefits equal to 90 percent or more of that income. The replacement ratio declines as income rises. The formula may be changed so that those with higher incomes in their working years have their replacement ratios reduced. It’s possible that people at some income levels will receive no Social Security retirement benefits.
  • A change in the index to determine initial benefits: The initial benefit payment is determined by taking a worker’s lifetime wages earned and inflating them based on average U.S. wage growth over the worker’s career. Historically, the Consumer Price Index (CPI) has risen at a lower rate than wages. In the future, the inflation adjustment may be based on increases in the CPI or a fixed rate instead of the growth in wages. This would lower initial benefits, but few people would notice and no one would see an actual reduction in benefits already being received. The change also could apply only to those age 50 and younger.
  • A change in the formula that indexes the benefits for inflation: Beneficiaries could receive less than full inflation indexing on their benefits.
  • A rise in payroll taxes: Those still working would pay more to fund their own benefits and the benefits of those already retired. The tax increase wouldn’t have to be across the board. Instead, the earnings limit on which Social Security taxes are imposed ($142,800 in 2021) could be raised or eliminated, as was done for Medicare.

Social Security’s solvency also may be improved by actions of beneficiaries. If fewer Baby Boomers are financially prepared for retirement, they may work longer and delay benefits. Because they would pay more taxes into the program during those additional working years, the financial condition of the program would improve. The improvement isn’t likely to be enough to prevent any future changes to the program, but it would extend its life for some years and allow other changes, such as higher taxes and reduced benefits, to be less extreme. The program’s financial health also could be improved if the young working population increases faster than expected.

Although we don’t expect the elimination or dramatic reduction of Social Security benefits, we do recommend that you make plans for possible changes in benefits. Those with higher retirement incomes should leave a cushion in their retirement budgets to accommodate possible means-testing. Those not already retired should plan for the possibility of lower retirement benefits than currently promised and higher taxes at some point during their working years.

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