July, 2008
by Dr. Thomas E. Bell, CMG Member, Michelson Awardee (Retired)
Tom received his Ph.D. in Management from UCLA many years ago, and was a consultant for about 25 years before he retired. He is a recipient of the A.A. Michelson award (in 1975), has served CMG as its Treasurer and its Secretary, and has repeatedly been on the CMG Board of Directors. He retired at the end of 2005.
About the Author
Dr. Thomas E. Bell
Social Security currently provides retirement benefits to lots of people, including me. If you're lucky, Social Security will provide you with significant retirement income too. The primary reason that it might fail to provide you with as much as anticipated: It has promised more than it can provide Baby Boomers. Nevertheless, you need to understand the general provisions of Social Security so you can keep your options open and react to whatever changes are made to it. (The over-commitments of the Medicare and Social Security programs are excellent examples of why you need to protect yourself with extra assets so your retirement won't go astray. Many of the characteristics provided below will likely be changed, and the changes may result in reductions in your benefits - and mine. Oh well.)
Both my May article and this month's deal with Federal Government programs. Understanding these is imperative if you are to protect yourself and your family, and if you are to make reasonable projections of your ability to retire. I waited entirely too long to understand Social Security, so I just had to move along without a well-formed plan. (I might have been able to retire with a higher Social Security benefit had I taken the effort to better understand the program and the various alternatives.)
The material in this article is greatly summarized and simplified to give you an introduction to the program; don't take the comments below as totally accurate descriptions. I strongly recommend that you go to the Social Security Administration web site (WWW.SocialSecurity.gov) for accurate information, and you might also want to seek help from a Certified Financial Planner or a Social Security representative to deal with issues that specifically affect your life.
You should receive annual projections from the Social Security Administration (approximately 3 months before your birthday) that list the annual income credited to you and outline your benefits. But in case you have lost them, you can still make your own projections. The amount from Social Security (at least given the current rules) may be a substantial portion of your retirement funds, so you really need to make sure about the recorded income and projected benefits.
Although the background, justification, and computation of your Social Security retirement benefits are complexi, you don't need to understand all those details. Instead, the Social Security folks have provided you with a web siteii where you can obtain three different types of estimates:
One of the important inputs is the age when you will begin taking benefitsiv. This age can be as young as 62 years old, or as late as 70 years; after that, further delay will just reduce your total benefits. The time you begin taking benefits is frequently called your "retirement age", and it will have a significant impact on your benefits.
Originally, the "full retirement age" (otherwise called the "normal retirement age") was 65, and most people were expected to retire at that age to receive their "PIA", Primary Insurance Amount. Changes in the Social Security rules in the early 1980s introduced a schedule of ages when people reach their full retirement age. For example, my full retirement age was 65 years and 6 months, but my wife's full retirement age was 65 years and 10 months because she was born after me. If you were born in 1962 or later, your full retirement age is 67. However, more and more people are beginning Social Security retirement benefits at age 62 (the earliest allowed age). Monthly benefits for early retirees (those beginning retirement benefits before their full retirement age) are reduced from the benefits that would begin at full retirement age, and they are increased when retirement is delayed beyond full retirement age. Specifically, the percentage of PIA when beginning benefits early is given at the following URL: http://www.socialsecurity.gov/retire2/agereduction.htm
The amount of your benefit isn't just some simple factor applied to your average annual earnings over 35 years. Instead, the computation basically uses three ranges of average salary; low salaries provide a much higher factor than higher salariesv. Therefore, low-income retirees have benefits far closer to those of higher-paid workers than their salaries would indicate; the difference may be very large.
Assumptions need to be made about the rate of inflation between today and the date of your retirement because the benefits have a "COLA" applied. A "COLA" is a Cost Of Living Adjustment that is based on the Department of Labor's Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). Each year, the benefits are increased by the rate of this inflation (which is different from, and generally higher than, the CPI-U, the Consumer Price Index for Urban consumers).
In order to receive Social Security retirement benefits, you or your spouse must have contributed to Social Security during your working career. This requirement may exclude government workers (who have their own retirement programs), but it doesn't require that an individual is a U.S. citizen. The specific requirement is that you must have accumulated 40 "credits" during your working career. The law currently gives you one credit for each quarter during which you have reported income of at least $1,050 (on which Social Security taxes have been paid), or four credits for $4,200 of reported income during a calendar year.
If you have worked for both normal employers and governmental organizations (including school districts), you may qualify for both Social Security and a government retirement program. However, you can't add the benefit amounts from both sources to determine your total. (If you could, your lower average salary in each would lead to unjustifiably higher benefits.) Instead, the Social Security benefits are reduced by an amount that is primarily dependent on Social Security earnings. The reduction is called the "Windfall Elimination Provision"vi. If this provision applies to you, your estimate of Social Security benefits should use only the second or third computational alternative from the Social Security Administration.
Up to 85% of your Social Security benefits may be taxed as normal incomevii, so don't just assume that they're tax exempt. Computation of the rate is a bit complicated, but you'll probably be stuck with the 85%, so you should probably assume that rate.
Your choice of your age for beginning retirement is quite important. As noted above, the "normal retirement age" to receive the Primary Insurance Amount increases through time. If you start receiving benefits earlier than that age, your monthly retirement benefits are permanently reducedviii, so selecting an early age (which will give you more payments) will reduce the amount per month. Several issues should be considered when making this important decision.
Your decision on when to begin benefits will, of course, be dependent on the amounts you will receive and how much you will need. You can determine the effects of your decision about retirement by going to the Social Security web siteix and clicking on your birth year. At the same URL you can also look at the issues suggested by the Social Security Administration.
My wife and I have been impressed by the knowledge and helpfulness of the representatives at the Social Security Administration. Before you're ready to make a decision about when you begin receiving benefits, you should call them up and ask for an appointment (for conversation either by telephone or in person). However, you can also contact a Certified Financial Planner who is expert in this area to obtain more extensive help; your broker may be able to suggest one or two.
The issue of spousal retirement benefits was where I really fell down. I sort of remembered that a spouse gets something if the primary provider dies, but that was it. My memory was actually about widow's and children's benefits, but that isn't what spousal benefits involve. (I really blew it.)
The Social Security program has provisions that provide retirement benefits to a spouse in addition to a primary wage earner. Of course, a spouse may have earned the 40 credits to entitle him/her to Social Security benefits (as mine did). However, he/she may have benefits that are less than half his/her spouse's benefits. In that case, the spouse's benefits are increased to 50% of his/her primary worker; the difference between the earned benefits and the 50% is called the "spousal benefit" in that case.
In the classic case of an employed husband and a wife caring for the family, the household will receive benefits that are at least 150% of the husband's benefits. In our case, my wife's individual benefits are less than 50% of mine, so her total benefits were increased to 50% of mine when her benefits started (in June 2008). In retrospect, I guess we might have had her contribute her time to our company for free (because we own our own company) and had me receive all the income. Then my benefits would have been greater and she would have received 50% of a larger amount. Oh well, too late now.
As you might imagine, many special rules apply to the case of a spouse who has, for example, been a teacher (as a "government employee") and not paid Social Security taxes. For such cases, the "Government Pension Offset Rule" may apply. For the retiree who may receive both Social Security and another pension from the government, the "Windfall Exemption Provision" may apply. Both of these reduce the amount paid by Social Security. All of this is a really complex quagmire where special aid is needed by those dealing with these rules.
Similarly, special rules (and possibilities to apply the rules beneficially) exist when the ages of the spouses are different. If you have a situation with a difference between spouses' ages that is more than a couple of years, you need to get help with how to protect the benefits of each one. You should research the topic at the Social Security web site, read the issues of "Ask Encore" in The Wall Street Journal, or talk with someone who really knows this stuff (like the Social Security Administration itself).
A number of special situations may apply, but the summary "bottom line" here is that a household with a husband and wife will receive at least 150% of the larger benefit of the two spouses. As you do projections about when you can retire, be sure to include this in your computations. However, there may be changes in the future that will affect whether you'll be able to count on that income.
Many people assume that they'll receive the anticipated benefits. Social Security has been able to handle the benefit payments in the past, and it will likely be able to for a while into the future. The problem is that the annual benefits for Baby Boomers will be far in excess of the annual benefits paid in the past, so retirees may have a much-reduced benefit in the future. If this is so, then you'll need more retirement savings than you may have planned on.
The core of the problem is that Baby Boomers reaching retirement age will require dramatically greater benefits payments, and the number of workers paying into the Social Security system will not increase proportionately. This is a big "whoops" that has been known for about 40 or 50 years, so it's no surprise.
The first figure shows the US population age distribution in 2000 (before the problem of the Baby Boomers became too apparent)x. Note the bulge from about age 35 through about age 54; that's the "Baby Boomers" born in 1946 through 1964.
I have added the dashed lines as well as the identification of the various parts of the population. The dashed lines show the decline in numbers of individuals as the age increases. Is this just from the normal death process; as people get older, they tend to die?
The second figure shows the forecasted situation 25 years later, after most (but not all) Baby Boomers have reached age 65. Note that the same dashed lines from the year 2000 demographics show the bulge of the Baby Boomers. Nope, the decline isn't just from normal dying; it is heavily influenced by all those individuals born between 1946 and 1964.
As shown in the third figure, the situation just keeps getting more dramatic. By 2050, the last of the Baby Boomers (born in 1964) will have reached 85, and that top line has gone from "just a few" to "huge".
Of course, the charts also show that the entire population is larger. So maybe the number of workers per retiree will stay the same. Think so?
The estimated number of workers per retiree at each of those times is as follows:
Year
2000
2025
2050
Workers per Retiree
4.76
3.08
2.59
In 2050 each worker will need to support about 1.8 times as many retirees as the workers did in 2000. The change in distribution of population ages will be dramatic, and it will have a major impact on society, and on Social Security. In addition, the services required by all those retirees mean that a large number of younger people will be required for providing them, but it doesn't look like they will be there in the numbers that are needed. This is a situation in which inflation will be the logical result ("more dollars chasing fewer goods and services"). That's a topic we will cover in next month's article.
An unfortunate characteristic of Social Security is that there is really not a real reserve to pay the higher total amount of benefits to which the Baby Boomers will be entitled. That is, the Federal Government hasn't provided each individual with an account somewhere (e.g., in a "lock box") that is reserved for that individual. It has, sort of, put some funds into the "Social Security Trust Fund" that can be used, sort of, to pay benefits to all those Baby Boomers. If funds aren't available to pay for Baby Boomer retirements, maybe there won't be funds for payments, and maybe you won't be paid; what about the "Trust Fund"?
The Trust Fund amounts are invested in special Government bonds that pay interest. However, their sale to the Social Security Administration is considered to be an intra-governmental transfer and the bonds are not recorded as liabilities; they are essentially treated as if their sale results in normal revenues (e.g., from income taxes). Although these bonds exist, their redemption would require that general Government revenues be diverted to pay them off. (This is kind of like "saving" for retirement by writing a $1,000 check to yourself each month and putting the checks in a safe; for retirement, you can just take those checks out of the safe and cash them later on. Sure.)
Some people (perhaps every sentient, knowledgeable individual) suspects that the politicians in Washington would be reluctant to significantly decrease other expenditures (e.g., bridges to nowhere, ear-marks, billions in subsidies to rich agribusinesses) just to pay off those nasty bonds. Whole studiesxi have been done to enumerate the alternatives that are available to handle the inadequacies of the Social Security taxes to pay benefits in the future.
Around 2017, Social Security taxes will be exceeded by the benefits that need to be paid in that year, and by about 2041 (though this is of questionable relevance) the Trust Fund will be exhausted. This will present an obvious problem, but the core problem has just begun happening. That core problem will become more obvious when the increase in excess payments (Social Security taxes in excess of benefits) goes down to zero, and this nice source of funds will stop getting bigger. This is already happening; Federal Government expenditures will need to stop depending on larger and larger excesses of Social Security taxes over benefits. I suspect that politicians will shortly begin taking a serious look for some way to avoid cutting other expenditures while handling Social Security payments.
Obvious targets to handle the situation are increases in Social Security tax rates, extending the top salary on which the tax applies (called the "cap"), increasing the death tax, and just running a deficit. However, an additional alternative is to reduce benefits to "those who already have enough retirement assets" - perhaps even by reducing the benefits all the way to zero. An argument can be made that the law doesn't allow that - but that's just until the law is changed. Given that benefits are already biased to provide low-income earners with a higher portion of their income, it doesn't seem impossible for politicians to just carry the idea out to its logical conclusionxii. Probably more likely, they may just cap benefits at a low level for higher income earners (e.g., most CMGers).
Would they actually do that? Who knows? However, many individuals born toward the end of the Baby Boom period seem to be assuming that the risk is too large for them to bask in confidence in professional politicians.
On a personal basis, you probably need to do at least two analyses:
The burden of having the working population support all the Baby Boomers in the style they anticipate may simply be too great. If this turns out to be so, you need to have your alternatives in hand. And act on them, before it's too late.
This short overview of Social Security retirement benefits has totally ignored survivor benefits and disability benefits (both of which are major parts of Social Security) as well as the many special rules and procedures that surround the program. You really need to read up on the program to find out how it will affect youxiii.
If anyone in your family is disabled (mentally or physically) you need to investigate their rights to disability benefits. These rights may be dependent on your earning history, your age, the disabled person's age, and other factors. Don't delay; rights may be compromised as folks (including you) grow older.
Because the currently-specified retirement benefits are substantial, you need to make projections about your retirement with them included (for both you and your spouse). Then you may want to see what the effect would be in the unfortunate case of your getting no Social Security benefitsxiv.
You can start taking benefits early, or start taking them late. However, changes in the Social Security program will need to be made to deal with the reality of the large total benefits for all those Baby Boomers. The best alternative for you, individually, in view of this: Be born before the end of 1941 (like me).
Otherwise, try to build up excess assets to compensate for potentially-reduced Social Security benefits.
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