Old Age, Survivors, and Disability Insurance (OASDI), otherwise known colloquially as “Social Security” is often ignored and even more often misunderstood. This article intends to give a basic overview of what Social Security can provide and some possible routes for how to consider it when planning your retirement.
As always, if you see something that isn’t correct or have suggestions on other things to add, please let me know in the comments or by private message.
What is Social Security?
Social Security is the United States’ national pension program. Social Security covers the vast majority of American workers, who pay into the program while employed in exchange for benefits when they become eligible.
Social Security, in most cases, is not a substitute for retirement savings. It will likely not cover all of your expenses in retirement. It should be considered supplementary to, not a replacement of, your own retirement savings such as IRAs and 401k plans.
How is your benefit calculated?
The calculation for an individual’s Social Security benefit is complex, but the four main components are:
- The history of your earnings for each year you worked and paid into SS.
- Each year of your earnings are indexed to the average national wage.
- The indexed earnings for your 35 highest wage-earning years (including years for which you earned $0) are averaged.
- A set of formulas are applied to “level out the playing field” between high earners and low earners. In other words, those with high incomes receive proportionately less from SS than those with low incomes.
What pops out is your benefit, or primary insurance amount. This is the amount you’ll be eligible to receive at your full retirement age. The Social Security Administration makes an annual statement available to you online that details your earnings history and expected benefits. You have to register for an account with the Social Security Administration here.
What’s my full retirement age?
Full retirement age is the age at which you receive your full primary insurance amount. If you were born after 1960, the age at which you can receive 100% of your primary insurance amount is 67.
What if I want to start taking benefits early? What if I want to wait?
The earliest age of eligibility for those with a full retirement age of 67 is 62 years. The benefit you receive at 62 is 70% of your primary insurance amount, and goes up to 100% on a monthly basis until full retirement age.
If you want or can afford to delay your SS benefit, it will increase by 2/3rds of 1% for each month you delay retirement (8% per year) up to age 70. Past age 70 there is no added value in delaying collecting your benefit. Thus, if your full retirement age is 67 and you delay collecting benefits until age 70, you’ll get 124% of your primary insurance amount.
Clearly delaying retirement as long as possible up to age 70 is to your benefit, all else equal.
Taxation of Social Security benefits
How your SS benefits are taxed is a mess. Hopefully you won’t think I’m copping out by saying that a full explanation is way beyond the scope of this post, but in short:
- For single taxpayers: If your adjusted gross income + nontaxable interest + 50% of your SS benefit is between $25 – $34k, 50% of your benefit may be taxable. If it’s greater than $34k, up to 85% may be taxable.
- For joint returns: If your combined adjusted gross income + nontaxable interest + 50% of your SS benefit is between $32 – $44k, 50% of your benefit may be taxable. If it’s greater than $44k, up to 85% may be taxable.
I’m a young person. Will I ever see a cent from Social Security, given how much trouble it’s in?
The short answer is most likely. Social Security is too popular to disappear, and for better or for worse it is firmly entrenched in the American political ethos. That said, SS outlays in recent years have far exceeded taxes. This could go a couple (or combination) of ways – an increase in the OASDI payroll tax, increased full retirement age, reduced primary insurance amount, more conservative adjustment for inflation, or other options I’m not thinking of at the moment. Never underestimate the political creativity of legislators to get blood from a stone. Unless major political change happens, however, everyone covered under SS should expect to receive at least “something” (probably around 75%) of their current projected primary insurance amount, made possible solely through tax income.
For a more detailed look at SS’s cash flow issues, see the delightfully clumsy-named (PDF) 2013 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Federal Disability Insurance Trust Funds.
One of the best (frankly, amazing) features of social security is the spouse benefit. Spouses over age 62 can opt to start collecting their own SS benefit (at the reduced amount) or elect to take the spouse benefit – 50% of the spouses’ primary insurance amount – while delaying their individual benefit. The Social Security Administration will even tell you which is higher. When you reach full retirement age you can elect to start drawing your own benefit or continue to draw the spouse benefit as long as you want until age 70.
This creates SS strategies in which one earner begins drawing their reduced benefit at age 62 while the spouse waits until age 67 or 70 to start withdrawing theirs. Depending on incomes and earning history, it may be significantly better for one spouse to wait to collect their benefit.
The spouse benefit is even generous in the event of the death of a spouse. A widow or widower is eligible to collect a survivor’s benefit starting at 60 years of age. If you or your spouse has already started collecting benefits and one member of the family dies, the survivor continues to receive the larger of their own benefit of your spouse’s benefit.
For a more in-depth discussion of spouse and survivor benefits, see this article which has several other links to good information about the matter.
Asset Allocation considerations
Considering Social Security in one’s asset allocation usually falls into one of two camps.
- It’s a bond – those treating SS payouts as part of their fixed income allocation usually use it as a reason to tilt more towards stocks than they otherwise would for a given age.
- It’s an annuity – Since SS benefits can’t be rebalanced, manually adjusted, or passed on in an estate, others simply include SS as part of their retirement income and as a way to reduce their drawdown requirements on their other retirement assets.
Since the future of SS payouts is somewhat uncertain (in terms of the amount, not if it will exist at all), in my opinion younger investors would do well to treat it as an income stream and not in one’s current asset allocation. However, this is highly dependent on one’s savings rate at the time of retirement. If one’s “safe” investments are enough to live comfortably you may be able to afford increasing your risk level by considering SS as part of your bond allocation. Alternatively, if you’re about to retire and are counting on Social Security to put you over the line between comfortable and scrimping you probably don’t want to use it as a justification for increasing risk in your other retirement investments.
Benefit Collection Strategies
Strategies for collecting benefits are as varied as those who collect them, but here are a few common ones and one that I thought was clever.
- Some start collecting at age 62, no questions asked. They take the approximately 30% hit on their primary insurance amount. Starting benefits between age 62 and the full retirement age causes a decreasingly small reduction in benefits depending on when one starts taking them.
- Others wait as long as they can to collect delayed retirement credits. Delayed retirement credits especially for those that have long life expectancies can make a huge difference.
- Therewas a rule that allows you to collect benefits at age 62 but then reapply for your full primary insurance amount plus delayed retirement credits at an age past your full retirement age, but that changed in 2010. Now you can only pay back benefits collected within one year of starting them. Social Security Timing offers some remedies for fixing withdrawal mistakes.
The Social Security program, for all of its faults, is still a great deal. Everyone that qualifies should be planning to take full advantage of it and its generous features.
The Social Security Administration website is the first stop for most SS issues. Like most government websites it has its quirks, but most of the explanations are fairly clear. It also has a benefits estimator.
IRS Publication 915 (PDF) delves into the nitty gritty of SS benefit taxation. Good luck staying awake.
Cite: This article has been contributed by aBoglehead — http://www.bogleheads.org/