What Do I Need To Know About Social Security Before Making An Informed Decision?

To copy a page from the inimitable Jeff Foxworthy, who made his mark on American audiences with “You may be a redneck if…” jokes, you may be a baby boomer if:

  • You know what a “sock hop” is.
  • You ever listened to “The Lone Ranger” on the radio.
  • You know who Howdy Doody was.
  • You ever used Brylcreem.
  • You can complete this song lyric: “I wonder, wonder, wonder, wonder who…”
  • The first photos of you are in black and white.
  • You ever used a metal ice tray with a lever.
  • Your family had one automobile and it had fins.
  • You know what a pet rock is.
  • Sean Connery will always be James Bond to you.
  • Your first allowance was payable to you in change.

Officially, baby boomers are those who were born between the years 1946 and 1964 when the birth rate in America rose dramatically following World War II. Those post-war babies have shaped the country and the world socially, philosophically and economically, and they are still doing it. The earliest of the boom generation are turning 65 at a rate of 10,000 per day. Words they applied to “old people” in the heyday of their own youth, such as “retirement” and “Social Security,” are now being used in connection with them.

Phillip Longman, in his research paper entitled, “Why Are So Many Baby Boomers Ill Prepared for Retirement?” makes the point that while boomers were great at inventing rock and roll and landing a man on the moon, the generation that gave us consumer credit and the two-car garage wasn’t so good at preparing for their golden years. While boomers earned more at every age of life than any other generation in history, they weren’t so good at saving it. The parents of boom children knew all about hard times. They were children of the Great Depression of the 1930s. But boomers were blessed with a cornucopia of plenty. Consumer credit made it easy to obtain new automobiles, nice homes with color televisions in each room and push-button gadgets that would have awed their grandparents.

If you are a baby boomer and can think back to when your parents retired, they probably didn’t give Social Security too much thought. They just drove down to their local Social Security office as soon as they turned 65, or maybe at age 62 if they retired early, and applied for benefits. They took their benefits for granted and didn’t ask many questions. Boomers, however, are approaching Social Security in a much different way. They have questions. “Will Social Security be there for me? How much can I expect to receive? When should I start taking my Social Security Benefits?”

Will Social Security Be Here for Me?

Baby boomers have all heard the rumor that Social Security is “going broke.” Is it true? Many of them may be wondering if they will someday get a letter marked “urgent!” by the Social Security Administration informing them that they would like to sincerely apologize, but this will be their last check because the kitty is out of cash. It’s a legitimate concern, all right.

In the 1990s, the financial services industry started sounding the alarm about Social Security in an effort to get baby boomers to save for retirement. Analysts pointed out that when Social Security was first instituted in 1935, there were some 40 workers paying into the system for every one retiree drawing benefits. But when baby boomers would be ready to retire, there would be only two or three workers paying into the system for every retiree drawing benefits. The math didn’t look so good.

But, like many things, what started out as a notification alarm bell quickly grew to an “end-of-the world” red alert. These irrational fears and misunderstandings about the solvency of the Social Security system have, in my opinion, gotten out of hand. Let’s look now at what the Social Security trustees say. Every year, they publish a comprehensive report showing the long-range outlook for Social Security, or the Old Age Survivors and Disability Insurance (OASDI) program, the official name for Social Security.

According to the 2011 Social Security Board of Trustees’ annual report, OASDI trust funds spent $736 billion in 2011, primarily paying out benefits to approximately 55 million people. Payments went to 38 million retired workers and their dependents, six million survivors of deceased workers and 11 million disabled workers. An estimated 158 million people paid payroll taxes in 2011, contributing $564 billion to the Social Security trust funds. All of that money going into the trust funds doesn’t just sit there. It earns interest. In 2011, that interest amounted to $114 billion, an effective annual interest rate of about 4.4%. Not too bad.

Now, granted, the trustees report indicated that trust funds are projected to be exhausted by 2033 unless changes are made. Several reforms were suggested that, over the next 75 years, would restore the program to solvency. But these plans will not be implemented for years to come. Meanwhile the trustees report confirms that Social Security’s trust funds are solvent and continue to grow. Even if left unchanged, which is unlikely to happen, the system would have enough to maintain full benefits until 2033.

What types of reforms are suggested? Although the Social Security system is not in imminent danger, most people agree that the earlier reforms are instituted, the less painful they will be on everyone. After all, we want our children and their children after them to benefit as we have. Here are just a few of the ideas that have been proposed:

  • Increase the maximum earnings subject to Social Security tax. At this writing, $113,700 in earnings is subject to the 6.2% tax paid by you and your employer.
  • Raise the normal retirement age to match life expectancy. As of this writing, full retirement age is 66 for people born between 1943 and 1954, and 67 for people born in 1960 or later.
  • Change the benefit formula so that future increases would occur at a slower pace. This would affect the benefits of future retirees.
  • Change the formula for cost-of-living adjustments. This could give retirees smaller benefit increases going forward, although the changes are expected to be minimal.

The bottom line for baby boomers is that their Social Security benefits are not likely to be affected much, if at all.

How Much Will I Receive?

Of course you want to know how much you stand to receive when you begin collecting your Social Security. As you will see by reading this blog, a lot of that depends on you and the decisions you make in the next few years. One of the functions of a professional retirement planner is that of nailing down the answer to that question. If you don’t have that answer nailed down, how can you do a budget and position your assets to adequately care for your expenses and meet your financial retirement goals? It would be like shooting at a moving target. When your Social Security benefit is calculated, it will be based on how much you earned over your working career and at what age you apply for benefits.

The formula for calculating Social Security is pretty complex. You may or may not want to follow along with this. If you don’t like the nuts and bolts of things, just skip to the next heading. But if you are like some people, you will find the formula interesting. You can use it to determine your own Social Security benefits.

The general process goes like this: First, Social Security looks at your annual earnings over your entire lifetime, indexes them for inflation, and picks the 35 highest years’ earnings to include in the formula. The indexed earnings are then totaled and divided by 35 to come up with an average. If you don’t have 35 years of earnings, the missing years will be filled in with zeroes. This has the effect of lowering Social Security benefits for parents, for example, who have taken time off work to care for children. However, they may be eligible for spousal benefits (more on that later).

Next, a formula is applied to your average indexed monthly earnings to determine your primary insurance amount. This is the amount you will receive when you reach full retirement age. As mentioned earlier, if you were born between 1943 and 1954, your full retirement age is 66. Each year, annual cost of living adjustments (COLAs) are applied to your benefit to help keep up with inflation.

Want to see an example of how this works? Let’s say that Joe B. Boomer, born in 1950, earned the Social Security maximum every year since he was 22. His average indexed monthly earnings would work out to be $8,238. In calculating his primary insurance amount (PIA), the first $767 would be multiplied by 90%. The amount between $767 and $4,624, or $3,857, would then be multiplied by 32%. And the amount over $4,624, or $3,614, would be multiplied by 15%. These amounts would be totaled to come up with a PIA of $2,466.60. This is the amount the worker would receive at full retirement age. I told you it was complicated. But that’s the government for you.

What Happens If I Apply for Benefits Early?

As we go forward, I think you will see just how important the answer to this question is. But for now, remember I said that your primary insurance amount, or PIA, is the benefit you will receive at full retirement age. So what happens if you apply for Social Security before you turn 66? Your benefit will be reduced. You will receive a percentage of your PIA depending on when you apply. If you apply at age 62, you will receive 75% of your PIA, at 63, 80%, and so on. These amounts are prorated, so you can apply anytime between the ages of 62 and 66 and your benefit will be reduced by the appropriate amount. Here’s an example: If you were born between 1943 and 1954 and you:

What Happens if I Apply after Full Retirement Age?

Excellent question! Full attention is also given to this in a subsequent blog, but for now, the short answer is that if you apply for Social Security after you turn 66, you will earn delayed credits of 8% for each year you delay. So if you apply at 67, your benefit will be 108% of your PIA. At 68 it will be 116%, and so on. After age 70 you can’t earn any more delayed credits, so it doesn’t pay to wait until after age 70 to apply for Social Security. Here’s an example. If you were born between 1943 and 1954 and you:

Note: COLAs are not factored into these amounts

Calculating Your Social Security

Hey, Mark! Is there an easier way to find out about how much you can expect to receive in Social Security benefits? Yes, actually, there is. You can dig out your annual Social Security statement, if you still have it. If not, you may go online and get it. To save costs, the Social Security Administration stopped mailing out annual statements. But as part of the Paperwork Reduction Act of 1995, you can probably access your statement online. You will have to jump through some hoops to get it, but the hoops aren’t too difficult. Go to this website: https://secure.ssa.gov/RIL/SiView.do and create an account. After agreeing to the terms of service, which has some comforting words about protecting your identity, and then a stiff-finger warning about providing false information, you can proceed to answer a few questions and set up your account. You may be surprised at how much of your work history Uncle Sam has been keeping up with. Under the “Earnings Record” tab of your “My Social Security” statement you will find your earnings history chronicled from your first job at the local car wash to your last year’s tax return. Looking at it in the format in which they present it, it sort of reminds me of the way tree rings reflect the good years and the lean years, income-wise.

On the “Estimated Benefits” tab, you will see the amount of your monthly Social Security income if you take it at FRA, age 70, and anywhere in between. Please note that the annual statement and the Retirement Estimator do not factor COLAs into your age-70 benefit. This means your actual benefit will likely be higher than they indicate. Your retirement planner will have a calculator that will adjust for COLAs. If you know your PIA, a professional retirement planner can project your future benefits. You might also find one of the three calculators at the Social Security website useful. Go to www.ssa.gov/planners/benefitcalculators.htm and follow the cookie crumb trail.

What about Spousal Benefits?

Social Security was instituted in an earlier era, when most married women did not work, so to describe them requires me to break with 21st century protocol and step over the boundaries of political correctness a bit. Using the traditional frame of reference, spousal benefits were instituted to give women a measure of financial security in their old age. The spousal benefit is 50% of the worker’s PIA if she applies for it at her full retirement age. If she applies at 62, it will be 35% of the worker’s PIA. So let’s say we have a couple here by the name of John, who is the primary worker, and Jane, who is his spouse. If John’s PIA is $2,000 and Jane’s PIA is $800, and if Jane applies for Social Security at her full retirement age, her benefit will equal 50% of John’s PIA, or $1,000. This is $200 more than her benefit based on her own work record. Regardless of why these spousal benefits were put in place, there exist some innovative ways baby boomers may take advantage of them to make their retirement more secure.

Here are the basic rules for spousal benefits: (1) The primary worker must have filed for benefits. If he wants to delay his benefit until age 70 in order to receive a higher amount, he can file for benefits at his full retirement age and ask that they be suspended. (2) The low-earning spouse must be at least 62 for a reduced benefit or 66 for the full spousal benefit. (3) Spousal benefits do not earn delayed credits after age 66. Other questions about spousal benefits will be address in subsequent blogs.

Divorced Spouse Benefits

One spouse can receive Social Security based on the work record of his or her former marriage partner, providing the marriage lasted 10 years or more and the spouse in question is currently unmarried. Yes, both husbands and wives can receive spousal benefits. Here are the basic rules for divorced-spouse benefits:

More than one ex-spouse can receive benefits on the same worker’s record. So if your ex-husband has remarried a couple of times, all three ex-wives can claim divorced-spouse benefits, as long as the marriages lasted at least 10 years.

The benefits paid to one ex-spouse do not affect those paid to the worker, the current spouse, or the other ex-spouses.

The worker will not be notified that the ex-spouse has applied for benefits. So you need not worry that your long-lost ex-husband will find out that you applied for benefits based on his work record. You do not need to know the ex-spouse’s whereabouts. You just have to have enough identifying information to enable the Social Security people to look up his records. You’ll also need to provide documentation showing the dates of the marriage and divorce. Divorce benefits stop upon remarriage, but you may then be eligible for spousal benefits based on your new mate’s work record. Or you may want to switch to your own benefit if you qualify for Social Security.

Survivor Benefits

The important thing to know about survivor benefits is that when one spouse dies, the surviving spouse receives the higher of the two benefits. Let’s say Joe and Julie are married. Both currently receive Social Security benefits. Joe’s benefit is $2,000 and Julie’s benefit is $1,200. If Joe dies, Julie’s $1,200 benefit will stop and she will start receiving $2,000. If Julie dies first, her $1,200 benefit will stop, and Joe will keep receiving his $2,000 benefit.

One important planning note: most widows and widowers need at least two-thirds of the amount of income they were receiving as a couple, so it is important to plan for the loss of one spouse’s Social Security benefit. Even though it is the higher benefit that will be retained, the death of a spouse means the loss of one Social Security check.

Basic rules for survivor benefits are as follows: In order for the surviving spouse to receive survivor benefits, the marriage must have lasted at least nine months, except in the case of an accidental death. To start benefits, the survivor must be at least 60, or 50 if disabled. However, if the widow or widower applies before full retirement age, the benefit will be reduced, as it is for regular retirement benefits. Some of the same principles that go into deciding when to apply for regular retirement benefits also apply to survivor benefits.

An Income You Can’t Outlive

Most people tend to minimize the value of Social Security. Don’t get me wrong. I realize that it is not the most significant piece of your retirement puzzle. If you think it is, then you may be in for a rude financial awakening once you retire. But it is a significant piece. Social Security is one of the few sources of income you can’t outlive. If you are worried about running out of personal assets in your old age, you need not have that fear with Social Security because it continues until you die. And, of course, the longer you live, the more you will extract from the system. More education is needed, however, about the moving parts of Social Security, and how to ensure that we make the most of them for our retirement. (Source for Social Security data: Savvy Social Security Seminar)