In an effort to be a full service resource for Empty Nesters, we devote Saturdays to nurturing the Nest Egg. Money can’t buy happiness, but as Thoreau said, it allows us to fully experience life. I actually had to look that up, thinking that Thoreau never struck me as a materialist. He probably was not, but he was a realist. And the reality is we when finally have free time, we want the ability to fill that time with things that make us happy. So lets make sure we can do that.
Financial planners talk about the three pillars: personal savings, employee pensions and social security. Today we tackle the social security pillar. First, a little context. Roosevelt signed the Social Security Act on August 14, 1935 with the nation in the throes of the Great Depression. That context explains the basic principles of the system we have 85 years later. As always, our extremists spoke loudly and impractically.
The far left clamored for increased taxes to pay benefits to the retired, the most popular proposal being a national sales tax as the funding vehicle. The far right saw any type of guaranteed payment as the certain ruin of American society, inevitably leading to a welfare state. While many are quick today to pillory FDR for plunging us into the age of entitlements, the truth is that he had to do something and the structure his administration produced was a moderate compromise.
Every paycheck you receive deducts 6.2% of your earnings (up to $137,700, this year’s maximum) as a contribution to the Social Security Retirement program. Your employer matched that amount. So if you make $100,000.00 in 2020, $12,400.00 will end up in Washington to fund the program. Almost everyone was against the contribution idea. The left preferred that the government tax either consumption or owners; certainly not workers. The right and the middle pointed out that because of the depression, we needed as much money in people’s pockets as possible. Roosevelt’s structure would pay a relatively small amount to the currently retired, but much more would be withheld from worker’s paychecks, reducing take-home pay when people needed it most.
The opponents had valid points, but FDR did not win four presidential elections without a fair degree of savvy. He wanted Social Security to last and knew that if the program depended on government appropriations, it would be an easy target for budget cutters in future presidencies. He rightly believed that if people personally contributed, they would not abide politicians who cut “their” benefits. Thus, the “third rail” of American politics.
That story has meaning for those of us who wonder about the future of social security. The first point is the one about much more money being taken out of worker’s paychecks. That situation remained true for decades. Where did all those extra contributions go? Contrary to popular belief, the extra income did not fund other programs of the federal government. Instead, the government deposited that extra income in a trust fund (or “lockbox” if you listened to Al Gore) that it uses only for social security purposes. So the money used to pay retirement benefits comes from: (1) the money being taken from today’s paychecks and the matching employer contributions; (2) interest earned by the trust fund; and (3) if 1 and 2 are insufficient, withdrawing principal from the trust fund.,
When you hear people say “Social Security is going broke,” what they mean is that there is more going out in retirement benefits than is coming in from contributions and trust fund interest. So we are reducing the approximately $2.5 trillion trust fund to pay current benefits. The actuaries tell us that if nothing changes in terms of benefits and contributions, the trust fund will run dry in 2035. That is bad, but it does not mean that there would be no money to pay benefits because there will still be money coming in from contributions. Those same actuaries predict that if the trust fund runs dry, we will still be receiving contributions equal to 76% of expenditures. The program would be short, but nowhere close to broke.
We have been down this road before and Congress has always acted to protect a retiree’s right to “full benefits.” In 2035, if it got that far, the political pressure to act similarly will be immense based on exactly what Roosevelt foresaw a century earlier. By definition there will be a large group of people who have contributed for years and who are very likely to vote. Few things are certain, but it is a great bet that sometime in the next 15 years, there will be legislation that increases contributions or decreases the benefits of those who have yet to receive them in a way that prevents the trust fund from running dry and protects your benefits.
Which brings us to your real question. How much will those benefits be. You are probably familiar with the periodic mailing from the Social Security Administration that predicts what you will get. Lets discuss that a little further so next year the mailer will mean something to you before it finds its way into the trash.
If you take nothing else away from this post, remember this: after you receive your first retirement social security check, your course is set. Before telling Uncle Sam to start sending the checks, make a conscious decision to fit the benefits into your retirement plan.
The basics you need to know for your account (spouses and even ex-spouses can sometimes receive benefits based on their spouse’s record, but we will get to that in another post). Generally, you will need to have worked at a job in which you and the employer contributed to social security for at least ten years, although that time can be spread over a working lifetime. Those ten years give you enough “credits” to qualify. Next, you must be at least 62 years old, which is the age at which you can start receiving early, reduced benefits. Finally, the Social Security Administration bases the benefit amount on your highest 35 years of contributions. To accomplish that last step, the administration adjusts the value of your contribution to reflect the passage of time. So if you maxed your contribution 40 years ago and only worked part-time recently, those early maximum contributions will count more heavily than your recent part-time work.
When Roosevelt signed the act, 65 was the magic number. Today, you can opt to begin your benefits at age 62, but you will pay a price. Doing so means your retirement checks will forever be 75% of what they would be if you had waited until full retirement age. If you live to be 100, early benefits could ended up costing you a decent amount of money. Of course, “full retirement” is no longer at age 65 unless you were born in 1937 or earlier. If you were born in 1937 you are 83 years old and I really hope you are getting paid at this point. I and everyone else born after 1960 can take “full benefits” beginning at age 67. If you were born in 1954 or earlier you are entitled to full benefits right now. For people born between 1955 and 1960, full benefits are around the corner but increase in increments of two months for every year. For instance, those born in 1955 can receive full benefits at age 66 years and 2 months; those born in 1956 have to wait until 66 years and 4 months. And you thought being “x years and a half” only meant something to first graders.
If you wait until after age 62, but start before full retirement age, the penalty reduces for each month you wait. But your figuring is not quite done! On the other side of full retirement, the formula will increase your benefits by 8% per year for up to four years if you do not get paid. So lets say that you have pretty steady earnings over your working life. Those earnings will produce a $2,500 monthly benefit if you retire at full retirement age. Your decision is this: should I retire early and start receiving a monthly check for $1,875.00; at age 62; retire “on time” and get $2,500.00 per month starting five years later; or wait as long as possible and rake in $3,300.00 monthly once I finally get started?
Every situation is different. It may be that you only recently reached peak earnings, so waiting increases the base amount amount of the check as well as the percentage multiplier. Your health may demand an earlier retirement. You may have enough savings or other pension payments that you do not need the extra money. Finally, remember that taking social security benefits does not mean that you cannot earn other income. If you do that, your benefits may be temporarily reduced and will almost certainly be taxed. We will look at both of those points in next weeks exciting installment.
Looping back to the original point though. There are no “takebacks.,” so think through your retirement decision carefully.
Until then, remember that every dime the U.S. Mint produces bears a bust of FDR for a reason, He set all this up for a reason. Social Security will be there to help with your retirement. It is up to you to make the most of us by carefully considering when you will start to take those benefits.