Social Security has developed a reputation for constantly being on the brink of crisis. A recent government report found that Social Security costs will exceed its income in 2020, and the program only has enough reserves for the next 16 years. Meanwhile, the steady stream of proposed changes to keep the program afloat creates tremendous uncertainty around what exactly Social Security will look like in the future.
It’s an emotional issue — and rightfully so — as everyone has the expectation that they’ll get back what they paid throughout their careers. According to the Social Security Administration, 25% of American retirees depend on Social Security for 90% or more of their income. It’s also a critical issue for retirement planning — individuals and couples of all ages, especially those nearing the end of their working lives, need to understand the role Social Security payouts will play during retirement.
When the Social Security Act was passed into law more than 80 years ago, it was intended to supplement retirement cash flow. The intent was to provide Americans around 40% of their average yearly income during their retirement years. Today, it’s the major income source for most retired individuals and couples. More than half of retirees rely on Social Security for at least half of their income, according to the Social Security Administration.
For wealthy families, there’s a justified uncertainty that any reforms will have a bigger impact on those with other sources of savings and retirement income. Reclaiming peace of mind and setting the right strategy for using Social Security starts with understanding what changes have been enacted and are being discussed.
Here’s a brief rundown of some of the Social Security changes being discussed in D.C. that would have the biggest impact on high-net-worth families planning for retirement.
Changes to Social Security taxes
The Social Security Administration increased the wage base for calculating the benefit to $132,900 for 2019 (up from $128,400 in 2018). That means any income an individual earns beyond that amount is not subject to the 6.2% Social Security tax. Officials have debated increasing this cap or removing it altogether, creating considerable tax liability for high earners, yet shoring up the Social Security trust fund significantly.
Another tax change being discussed is applying Social Security payroll taxes to all salary reduction plans. Currently employees pay Social Security tax on retirement accounts like 401(k) plans. This proposal calls for adding the tax to other types of benefit plans, including flexible spending accounts.
Changes to how Social Security benefits are calculated
The annual Social Security Cost of Living Adjustment (COLA) was set at 2.8% for 2019. These increases sometimes fail to keep pace with inflation, particularly when it comes to rising health care costs, which are typically a major source of spending for retirees. Legislation has been proposed to change the index used to calculate this adjustment. These proposals include switching to a chained consumer price index, which would create smaller, more consistent adjustments year to year, and the Consumer Price Index for the Elderly, which more closely reflects the actual inflation retired consumers experience based on their spending habits.
Another proposal would increase the number of working years used to calculate an individual’s Social Security benefit from 35 to 38 or 40 years. For a majority of Americans, this would factor in more years with lower (or no) earnings and would reduce the overall benefit.
Finally, one of the most straightforward ideas that’s been discussed for quite some time is to raise the full retirement (currently 65 to 67) and early eligibility ages (currently age 62), impacting when future retirees could claim their benefits.
Maximizing Social Security’s role in retirement planning
These recent and proposed changes to the Social Security landscape have the potential to impact how Social Security can be used to maximize retirement earnings and minimize tax impacts. For many individuals and families, the most significant Social Security variable they can control is deciding when to collect. Waiting to collect means a greater payout as benefits increase by 8% annually from full retirement age to age 70, but it might not be the right course of action in every situation.
Here are three factors my firm, Wescott Financial, advises clients to consider:
Individuals who expect to live longer may want to opt to wait until age 70 to collect, while those suffering from chronic conditions that impact life expectancy may want to begin collecting earlier.
Married couples can maximize their overall Social Security earnings by delaying the higher-earning spouse’s benefit. Also, a delay in collecting creates a larger survivor’s benefit.
If there is a large age difference and the lower-earning spouse is older, it may boost overall benefits for the higher earner to take Social Security benefits earlier so the older spouse can begin collecting spousal benefits.
Further, couples born before Jan. 2, 1954, have an additional tool known as a restricted application, which allows the higher-earning individual to collect only spousal benefits while his or her benefit grows and then switch to his or her own benefit at age 70.
It’s important to look at Social Security benefits in the context of overall cash flow. In some cases, speeding up or delaying benefits could change the tax bracket an individual fall into and the tax impact of other retirement income sources, such as capital gains.
Maximizing Social Security’s role in retirement planning
Wescott uses a long-term cash flow analysis to determine the best approach for maximizing Social Security in retirement. Evaluating clients’ unique situation as they both anticipate and enter their early retirement years, individuals and families can feel confident that they’re employing the strategy that maximizes their family’s income.
Grant Rawdin is Founder and CEO of Wescott Financial Advisory Group LLC. He founded the firm in 1987, which grew from the tax, business and estate services he provided to clients at Duane Morris LLP, a venerable AMLaw 100 law firm. Grant is an attorney, an accountant and a Certified Financial Planner™ and has served as adviser to many businesses, providing strategic, ongoing, and M&A advice. Grant and Wescott are recognized as leading the investment and financial planning industry in innovation, growth and size.
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