The Bogleheads' Guide to Retirement Planning (29 page)

Social Security’s formal name is Old-Age, Survivors, and Disability Insurance (OASDI). Federal law specifies the main features of Social Security, which only Congress can change. The Social Security Administration (SSA) issues detailed rules and forms, communicates with you, and pays benefits. The Internal Revenue Service (IRS) collects the taxes that support Social Security.

This chapter answers some basic Social Security questions about retirement benefits for workers and their spouses. Chapter 14 will explain how Social Security protects workers and their families before retirement age with disability and survivor benefits. The information in this book can only act as a guide. The best source for detailed information is the Social Security Administration.

Social Security laws are vast and complex. The system covers a wide range of recipients who receive hundreds of billions of dollars per year from the government. Generally, people are familiar with old-age benefits; however, the law covers much more, including disability benefits; benefits for a surviving spouse of a deceased worker, surviving child of a deceased worker, or surviving parent of a deceased worker; benefits for a spouse of an old-age or disability benefits recipient; and benefits for children of an old-age or disability benefits recipient. This chapter concentrates on Social Security old-age benefits.

Social Security covers about 95 percent of American workers, including nearly every worker in private employment. The noncovered workers include some railroad workers and employees of a few state and local governments that opted out of the program years ago. A relatively few other workers are excluded by law because of special occupations, religious beliefs (such as the Amish), and other reasons. Household workers or family members are excluded if their annual wages are very small.

Social Security covers uniformed members of the military, as well as most others within the federal government. It covers civilian employees who (a) are elected or appointed officials or judges, (b) were hired after 1983, (c) were rehired after 1983 following a break in service of more than a year, or (d) elected to transfer to a federal retirement program that includes Social Security. By about the middle of this century, all federal government employees will be under Social Security.

In state and local government, most employers elected to cover their employees by Social Security during the 1950s. Noncovered state and local employees are those who never came into the program and certain formerly covered groups whose employers elected to terminate coverage before 1984. Congress changed the rules in 1983 to prevent any more groups from dropping out of Social Security. About 70 percent of state and local government employees are now covered.

The amount of your Social Security retirement benefit is based on your year of birth, your age when your benefits begin, and the earnings on which you paid Social Security payroll taxes—not on the amount of taxes you paid. This section explains the benefit rules and has numerical examples. References given later list computer programs for estimating your benefit or calculating it exactly.

Social Security isn’t adequate for most people to maintain a comfortable standard of living in retirement. It is designed to provide a floor, a minimum level of income to partially replace earned income. Social Security provides a base that you can build on with employer plan benefits, personal savings, and part-time work. Retirement income from Social Security has the extra benefit of an automatic cost-of-living adjustment (COLA) that increases your payments annually to keep pace with inflation.

You should apply for benefits about three months before you want them to begin. It also helps to discuss your situation with a Social Security representative about a year before you apply.

You may apply for your benefits to begin between the ages of 62 and 70 if you have at least 10 years of coverage. A retired worker’s spouse can apply for benefits at age 62 or later. A surviving spouse of a worker or retired worker can apply at age 60 or later.

A divorced spouse who was married to a retired worker for at least 10 years and is unmarried may start benefits at age 62 or later. Benefits payable to your ex-spouse do not affect the benefits payable to you or your current spouse. If you apply for two benefits, for example, as a worker and a spouse, you get only the larger one. Federal law now defines marriage as between one man and one woman for purposes of all federal programs. Social Security recognizes common law marriages but not same-sex marriages.

Workers and former workers receive a personal statement from SSA by mail each year after age 25 or on request at any age. Your statement shows year-by-year earnings on which you have paid Social Security taxes. It also summarizes the estimated benefit amounts you and your family may get as a result of those earnings. The statement is a handy guide to your benefits. It also gives you a chance to correct any errors in the official record of your earnings.

Your basic benefit amount as a worker (sometimes called the primary insurance amount) is computed by a very complex set of formulas. The formulas go through these four steps:

The resulting basic benefit amount gets adjusted annually after age 62 to keep up with inflation, based on changes in the consumer price index (CPI). For more information, see “Your Retirement Benefit: How It Is Figured” at
www.ssa.gov
.

For a worker’s spouse, the basic benefit is half of the worker’s benefit while both spouses are alive. For a surviving spouse, the basic benefit is equal to the deceased worker’s benefit. The basic benefit for a worker, spouse, or surviving spouse is reduced if it begins before the individual’s full retirement age.

Full retirement age is the age when you can get a full benefit—an important milestone. Social Security retirement benefits that begin sooner are reduced, and benefits that begin later are increased. If you were born after 1942, your full retirement age is in the range of 66 to 67, as shown in
Table 11.1
.

Once you reach full retirement age, there’s no limit on how much income you can earn without any reduction in your benefit by the retirement earnings test (explained later).
Table 11.2
illustrates the amount of a worker’s basic benefit at full retirement age 66 in 2008, based on four different patterns of preretirement earnings.

Note that as a worker’s earnings go up, the benefit amount increases, but the percentage of preretirement earnings decreases. For workers who retire after 2008, these same percentages will apply at their full retirement age, with earnings patterns and benefit amounts adjusted to 2008 dollars.

Source:
2008 OASDI Trustees’ Report, Table V.C3

Source:
2008 OASDI Trustees’ Report, Table VI.F.10

If you work while you get a Social Security retirement or survivor benefit, the retirement earnings test may reduce your benefit temporarily. This rule counts only money you earn from working, not income from investments.

At full retirement age, SSA automatically recalculates your benefit and gives you credit for any months when your benefit was reduced or withheld. Thus, if the retirement earnings test takes away some of your benefit, you get it back later. Your benefit will also increase if your latest earnings were high enough to raise your 35-year average earnings record.

Your Social Security benefit may be reduced if you get a pension from work not covered by Social Security. In that case:

Software for estimating an individual’s Social Security benefit often disregards both these provisions and thus may overstate your actual benefit.

The rules are very complex for determining whether any of your benefit is taxable as income and how much is taxable. There are two considerations: the amount of Social Security benefit that is taxed and the marginal rate you pay on that amount. The income you earn from other sources has a direct impact on the amount of Social Security benefit subject to tax and the marginal tax rate you pay on the benefit. The information that follows is a basic overview. Chapter 2 provides more information on marginal rates.

The IRS treats up to 85 percent of an individual’s Social Security benefit that is above a base amount as taxable income. For most taxpayers receiving Social Security, the base amount is high enough that none of their benefit is taxed now. But the base amount doesn’t go up with inflation, so in future years, more and more retirees will pay tax on their Social Security benefit.

State and local tax treatment varies widely. Most of the states with an income tax do not tax Social Security benefits. Most of those states that do tax benefits offer a deduction or other relief rather than taxing the same amount as the IRS does. Detailed information on state tax policy as it relates to Social Security is available at the AARP web site,
www.aarp.org.
.

Table 11.3
gives a very rough approximation of the amount of your benefit that will be subject to tax. The percentage of your benefit that’s reportable as income for tax purposes can vary from zero to 85 percent, depending on how much other income you have. Provisional income in
Table 11.3
is the sum of your adjusted gross income (excluding Social Security), any tax-exempt interest, and half of your Social Security benefit.