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Scott Burns' Articles -- Recent and Archived

Social Security, Taxes and Deferral

Q: I'm 34 years old and, despite my master's degree in public policy, a little confused by the numbers Social Security sends me in their little green and white "Social Security Statement" mailer. They say that if I retire at age 67, my payment would be $1,984 per month -- less if I retire early, more if I defer.

What I can't figure, despite having read the mailer cover to cover, is whether they're talking in terms of today's dollars or whether this is their projection of the actual dollar amount I'll receive in 2039. Obviously two grand a month in today's dollars sounds a lot better than two grand a month in 2039 dollars. -- J.M., Seattle

A: They are talking in constant dollars. Your benefit would be adjusted upward each year to reflect inflation. If inflation averages 3 percent a year, your future benefit would be about $5,262 a month -- even though its purchasing power would be the same as $1,984 today.

Sadly, the increase in nominal dollars will have a terrible side effect -- you will pay much more in income taxes than someone retiring today on the same purchasing power.

How can this be?

You can thank politicians of both parties for this generational atrocity. The formula for the taxation of Social Security benefits is not indexed for inflation. For a single taxpayer, your Social Security benefits start becoming taxable when half your benefit plus your other income exceeds $25,000. Since your future benefits will be about $63,144, half of which is $31,572, you will have triggered the taxation of your benefits without ANY income from any other sources.

This tax inequity for the young is why I have suggested that young people should prefer Roth IRAs over traditional tax-deferred savings. It is also one of the reasons economist Larry Kotlikoff and I advocated scrapping the entire tax system and replacing it with a national sales tax in "The Coming Generational Storm" (MIT Press, $18).

This tax was passed in 1983, when you were 11 years old.

Today, we call that generational inequity. In 1776, the same kind of thing was called "taxation without representation.

Q: In your recent article "Do the Math: Deferring Social Security Pays Off," you mention that your Social Security benefits would increase by $11.63 a month until your monthly benefit would reach $2,623, as opposed to $1,995 if you collected the benefits at an earlier age.

I am having a devil of a time figuring out how and why that number, $11.63, is provided. It seems as if your monthly benefit would increase by $628 a month by waiting the 54 months.

Forgive me if I am overlooking the obvious or failing to understand how Social Security increases its benefits, but if you forgo 54 months of $1,995, it seems that indeed $628 per month will fall short of recouping the difference. -- D.E., Seattle

A: It may make more sense if you consider a shorter time period. If I defer taking benefits for 12 months, I will forgo $24,000 in benefits. My delayed benefit, however, will have increased by $11.63 per month, per month of deferral, as calculated by Social Security.

That's $140 a month over a year, or a $1,675-a-year increase for the remainder of my life.

The same increase will go to my surviving spouse when I die, so the payments are likely to be made for at least 25 years. In addition, the $140-a-month benefit increase will be adjusted for inflation each year.

That leaves us with a question: If I took the $24,000 in benefits and did not have to pay any taxes on them, what investment could I make that would do the same thing?

The $1,675 a year represents a 7 percent return on $24,000. I could invest the money and take the risk of the stock market, but the odds are that I would deplete the investment long before death.

I could purchase a joint and survivor life annuity that guaranteed $1,675 a year, adjusted for inflation. But it would require an investment of $36,000. Giving up $24,000 to have a benefit increase that would require a $36,000 investment looks like a slam dunk.

Deferral looks even better when you consider taxes. If you have enough income, whether working or retired, your Social Security benefits will be taxed. So you'll have less money to invest in a substitute for deferral.

Every year, more and more retirees are discovering that they must pay taxes on their Social Security benefits.

ON THE WEB

"A Real-Life Case for Delaying Social Security Benefits"

  

Published Nov 15 2006, 06:00 PM by scottb
Filed under: ,

Comments

 

ABModerator03 said:

I read your column about deferring Soc. Sec. payments and was wondering if all these calculations about the cross over or catch up point took into account the inflation rate, lost income that the payments could earn over those 14 years and taxes on that income.

George

  

From Scott Burns:

Yes, it does. One way to examine it is to compare what you would pay for a private, inflation adjusted life annuity with the amount of Social Security income deferred. In the column, for instance, I pointed out that deferring $24,000 in benefits for one year would increase the lifetime income of me and my spouse by an amount that would require a $36,000 investment.

Another thing many readers don't consider is the possible burden of taxes on Social Security benefits. I'm deferring mine because they would be fully taxed this year and are likely to be fully taxed for the next several years. As a consequence, the amount you can invest is reduced and, of course, the earnings from the new investment is also reduced by income taxes.
November 15, 2006 8:34 PM
 

ABModerator03 said:

Instead of trying to eat the whole elephant of revising US tax law. Why not take just one bite by writing our representatives and senators to increase the SS wage caps for annual inflation. It won't solve the broader tax issues which politicians seem to be adept at ignoring. However, it would those who will receive SS payments in the future. Gee, while I'm dreaming maybe we can get the AMT fixed also.

BigOil1

From Scott Burns:

The "just one bite" approach is what our elected representatives have been doing for decades. It's great for them. Lousy for us. That's why we have the mess we have--- and why so many laws written with good intentions have such perverse effects.

When I was in my 20's, 30's, 40's, and 50's I listened to the arguments between Democrats and Republicans about taxes. That's a long time to be patient. Maybe a long time to be stupid and naïve.

But the now annual Circus of Envy and Incentive is just manipulative junk thinking that distracts all of us, left or right, from the fact that we are regularly empowering one party or the other to spend our money through taxes or increased federal debt.

I now firmly believe that if we want our children to enjoy the freedom we have enjoyed, if we want a strong and competitive economy, we need to junk our entire tax system and start over with a single tax on consumption.  
November 16, 2006 12:21 PM
 

ABModerator03 said:

In your column in the Dallas Morning News on November 16 you discuss the advantages vs disadvantages of drawing SS early. You mention that for a single taxpayer their benefits become taxable when other income plus 1/2 of their benefits exceeds $25,000.

My wife started drawing her benefits this year. I tool my benefits at age 62. We were told when my wife signed up that we could each make $1000 per month net before we would be taxed on our benefits.

Together we draw $2385 per month. At what income will our benefits be taxed.

Thanks and regards,

Richard

  

From Scott Burns:

You and your Social Security representative were probably talking about two different things but didn't know it.

Early retirees--- those who take benefits before reaching their full retirement age--- can have their benefits reduced (not taxed, reduced) if their wage individual earnings exceed a certain amount--- $12,480 for 2006. Over that and benefits must be returned. If you visit the Social Security website, www.ssa.gov, click on "Questions about earnings and employment," and then click on the first question ("How much can I earn and still receive Social Security benefits?") you'll find more information and an online calculator.

Retirees of any age may also be liable for income taxes on their benefits if their income exceeds certain amounts--- $25,000 on a single return, $32,000 on a joint return where the income includes half of your Social Security benefits. In your case, a portion of your benefits will be added to your taxable income when your income from other sources exceeds $17,690. ($32,000 less [ ½ x Your Social Security benefits]=$17,690).

According to the Social Security website, about one-third of all Social Security benefits recipients are now subject to some level of this tax. Because the threshold amounts--- that $25,000 and $32,000--- are not indexed and have not been changed since the tax was passed in 1983, more retirees face this tax every year. While there is much attention to the dreaded Alternative Minimum Tax (AMT), there is relatively little attention to this wretched tax that will have a far bigger impact on the young when they are old enough to retire.

This tax is one of the reasons I have advocated chucking the entire tax code and starting over--- with the Fair Tax proposal for a national sales tax.
November 17, 2006 11:28 AM
 

ABModerator03 said:

Mr Burns-

Your November 15 column answered an important question about Social Security- the annual statements regarding retirement payments are in constant dollars. Another question, not well addressed in the statements is, How do the amount of future earnings (and Social Security Tax contributions) affect my projected amount of monthly benefits?

My statement says I am already qualified, and that if I retire at the full retirement age of 66 (eight years from now), I will receive $1,926 a month. However, it also says, in calculating those benefits, "For 2006 and later (up to retirement age), we assumed you'll continue to work and make about the same as you did in 2004 and 2005".

I have become self-employed as a form of semi-retirement and do not come near paying the maximum amount (based on $94,200 in earnings) in Social Security taxes now, as I did in 13 out of the last 15 years when I worked for corporations.

Am I at risk of having my future social security retirement benefit reduced because I make substantially less now and in the future than I did earlier in my career, and because I do not make enough to pay the maximum tax? Thank you.

From Scott Burns

I've got bad news and good news for you.

The bad news:

Your future Social Security will be reduced if your future earnings are not what Social Security projects. This will happen because your average earnings level will decline, reflecting the added years of income at lower levels.

The good news:

Your future Social Security benefit won't be reduced as much as you would expect because the formula for benefits is, in effect, a steep graduated income tax. Low wage earners get a lot of benefits per dollar of earned income. High wage earners get less in benefits per dollar of income.

How much lower your benefit will be will depend on your wages in the future and how they affect your long term wage average.  
November 17, 2006 5:49 PM
 

ABModerator03 said:

Scott,

Like the Gooddog comment, I too have changed jobs over the past 3 years and no longer make the maximum Soc Sec wage limit. I made the max wages for all my working career until 2004 and may not regain that level again. I plan to work until 70 if I can and not collect SS until that age. But, by working until that age and not making the wage max could lead to my last 10 years of wages being lower than the maximun in the SS formula (25 years of max wages with 10 years of below max wages, from age 60 to 70). Should that be a concern?

Tom

From Scott Burns:

No, it should not be a big concern due to the low crediting rate for wages in excess of $4,100 a month--- only 15 percent versus 90 percent for the first $680 a month, or so. As a consequence, an earnings shortfall from top wages isn't nearly as damaging to your long term benefit entitlement as you would think.

Alas, I don't know of any research that has provided a matrix of years x shortfall with estimated benefit changes. Such a table, even proximate, would be a useful tool.  
November 20, 2006 10:57 AM
 

ABModerator03 said:

Dear Scott,

My husband and I starting taking social security at age 62 this year, my benefit being a spousal benefit. If my husband were to die before I do, would I get his amount as a surviving spouse, or my current spousal amount (half his), or both? What if I die first?

Sincerely,

Sharon

  

From Scott Burns:

Technically, you will receive your benefit plus the amount by which his benefit exceeds yours. But it amounts to simply receiving his benefit, assuming it is higher, in the event of his death. If you die first your husband will continue to receive his benefit but yours will stop.

If your benefit is  ½ of the benefit your husband receives, either death would result in an income loss of about 1/3 from your present level. In theory, this should pose no financial hardship since living expenses would decline. As a practical matter, however, many expenses don't changes--- such as shelter, telephone, cable, etc. etc. so there is often a reduction in standard of living for the surviving spouse.
November 20, 2006 11:32 AM
 

ABModerator03 said:

Scott,

I agree with you that our tax system is fundamentally flawed and frequently drives the wrong economic behaviors. I'm in favor of throwing out the whole mess and starting over with a national sales tax.

Like you I'm disappointed that we've (us and our electees) have had many opportunities to fix this problem but always come up short. Ain't nothing going to happen until we taxpayers decide to act for the common good and clamor for changes. Our electees aren't going to anything for the common good unless we the voters raise a big enough clamor to get their collective attention. Unfortunately, replacing the existing tax code didn't have much (any) visibility this last election cycle so I'm not sure you and I will see a change before we die.

A lot of smart folks have worked to change our tax system, unfortunately we have wound up with this cobbled up system that has huge disincentives for rational economic behaviors. Maybe the way folks like Fair Tax.org who are trying to change the existing tax system need to change their tactics. What's the saying about "doing things the same way and expecting a different outcome".

Regards, BigOil1

From Scott Burns:

The saying is "The definition of insanity is doing the same thing over and over but expecting a different result."

I believe public disgust and distrust of both parties is approaching the level needed to force real reform of our tax system. It happened in the mid-80's. It can happen again.
November 20, 2006 1:45 PM
 

ABModerator03 said:

This is in response to your column in the November 28 edition of the St. Petersburg Times.

I am a victim of the way Social Security benefits are taxed. I understand that about 10% of Social Security beneficiaries had to pay income tax on their benefits in 1984. The figure is now about 18%. Unless the formula is indexed for inflation, almost all beneficiaries will eventually have to pay income on their benefits.

Most people don't know that the income tax paid on Social Security benefits come back to the Social Security and the Hospital Insurance trust funds. If they knew this , they may find the taxation of benefits more palatable. In 2005, the Social Security trust funds (OASI and DI) received 14.9 billion dollars. The Hospital Insurance (HI) trust fund received 8.8 billion dollars.

In an effort to save Social Security, the thresholds may be eliminated and everyone, regardless of income, will pay income taxes on Social security benefits.

  

From Scott Burns:

The thresholds are being eliminated by inflation. If you take the Social Security Trustees projections of benefits and adjust them for their own inflation estimates you'll find that many workers now in their 20s, particularly two earner couples, will trigger benefit taxation on their benefits alone. With the threshold for a couple at $32,000, they only need benefits of $64,000 to cross the line. Sounds high today, but when I was in my early 20's Cokes still cost a dime and gasoline was about 30 cents a gallon…

An average worker retiring today can expect benefits around $1,400 a month. Multiply by two for the typical couple and you've go $2,800 a month or $33,600 a year in benefits. That would be $64,000 in only 22 years if inflation runs at 3 percent. It would be just under 17 years at 4 percent inflation.

It wouldn't be difficult to make a case that the old "marriage tax" is morphing to a marriage tax on the elderly.

You can read more about this, and understand what it means for young people, by reading "The Coming Generational Storm" (MIT Press, 2004) which I coauthored with economist Larry Kotlikoff.
November 29, 2006 12:13 PM
 

ABModerator03 said:

I have enjoyed your column in the Dallas Morning News and your recent article (above) in the USAA Magazine. I am afraid you left out a very important consideration - whether social security will even be available to certain groups of people and if it is how much will it be reduced.

I turned 65 in October and at 65 and 9 months when there is no penalty for working, I will probably start taking my social security for the following reasons:

1. The Trust Fund can not continue as it is today due to too few workers supporting too many retirees in the future, 2. The Congress first started taxing most of your social security check without any consideration as to how much one contributed and now medicare starting in January is charging an additional premium based on an individuals earnings as shown on a prior tax return, thus one can expect the Congress to start "means testing" social security at some time in the future.

James

  

From Scott Burns:

I certainly agree about the danger of reduced benefits in the future. Otherwise I would not have coauthored "The Coming Generational Storm" (MIT Press, 2004) with economist Larry Kotlikoff. I've also written more than any journalist I know about the taxation of Social Security benefits and the impact of Medicare Part "B" premiums on benefits.

With all that, however, it's not an all or none thing. For all practical purposes, Social Security benefits are already means tested. The benefits that accrue to higher wage workers are (1)small relative to taxes paid and (2)most likely to be taxed. Because of the way the taxation formula is constructed (with no indexation) young people can expect all of their benefits to be taxable. Even so, delaying benefits is good economics for married men and works pretty nicely for single women as well.
November 29, 2006 12:26 PM
 

ABModerator03 said:

Scott,

Happy Holidays to you. This week I received the USAA Winter 2006 magazine which contained your article entitled "Delayed Gratification".

I am one of the owners and operators of http://www.financialmedic.com/ . In developing the retirement planning service and now while it's in operation, we spend considerable time testing cases. I looked at the case in your article but came to the conclusion that "it makes sense to take your money and run".

Using the numbers in the article, the additional $1675 gained by delaying the start of social security payments will grow (my assumption) with an annual inflation escalator of 2.5% to $1764 per month at the end of the 26 year retirement period. But to fill the income gap, the client will have to withdraw $23,940 ($1995 per month) of retirement funds which will be taxed as ordinary income. In the 15% incremental tax bracket in effect the client will see $1696 per month after taxes.

Rather than compare the benefit of delay to a one time annuity, I suggest that the better option is to keep the $1995 in an IRA which has been growing at a 12% per annum for the last five years. After 26 years, the monthly asset has grown to $2584 which is 46% more than the $1764 gained form the delay strategy. Understood that the $2584 is before tax and there is no certainty that the fund will continue to grow at 1% per month. But that 46% differential certainly provides a cushion against the tax and risk factors.

What am I missing? Thanks in advance for your response.

peter

  

From Scott Burns:

The question is about lifetime income for consumption. It is not a speculation about accumulation.

If you defer taking benefits for one year you lose $23,940 of consumption. If you take $23,940 from a retirement account, that money will be taxed. The $1675 annual gain in benefits with lifetime inflation adjustments, however, has a lifetime inflation adjusted annuity value of $36,000. If you assume that NONE of the Social Security benefits will ever be taxed, deferral is still worthwhile because you would only have to take $28,164.70 ($23,940 divided by 0.85) to have $23,940 of spendable income. That's still less than the $36,000 you would need to invest to get the equivalent increase in lifetime income by deferring SS benefits.

While many people without other resources will have to take SS benefits early, many of the people who will consider delaying the benefits will also know that their benefits will be subject to taxation.
December 7, 2006 11:40 PM
 

ABModerator03 said:

You hint at the real issue in SS deferral in the third paragraph of the answer when you say "payments are likely to be made for 25 years." But that' true in your example only if the surviving spouse is much younger and/or from hardier stock (and made less than you and a lot of other variables that we'll keep out of the equation).

Bottom line in your example: it's going to take the person that defers $24,000 for a year 14 years and 3 months to catch up. In making the deferral decision, basically each person has to ask themselves if they are going to live much longer than average. If the answer is yes, defer. If no, take the money and go to Florida or Arizona or Palm Springs now.

Dennis

From Scott Burns:

As stated in the original column on the subject, the biggest beneficiary for a delay in SS benefits will be a married male because either he or his spouse is likely to benefit and their joint life expectancy is around 24 years. The 24 year figure is the typical joint survivorship period for a 65 year old male with a 62 year old spouse. Three years is the typical age gap between husband and wife in the first marriage. (All bets are off in the second…)

The Center for Retirement Research paper cited in the original column gives all the details for differences in age and relative income for spouses. It's worth your time and study. To me, the compelling case is the simple one of asking how much it would cost to buy a joint and survivor life annuity with inflation adjustments for the same amount of income that SS benefits would increase. If the cost of the life annuity is materially greater than the SS income foregone, then deferral is a good, and conservative choice. In my case, I would have to pay $36,000 to get a life annuity that would provide the same increase in income as $24,000 of SS deferral.

Thanks for your response. I would like to look at the CRR paper you refer to but I can't tell either from your archives or their site what the title is. If you have a link or a title I would appreciate it.

(By the way, while roaming the CRR site I came across a spreadsheet that gave the average holdings of a typical household prior to retirement. Any idea how they came up with a value for the average household's Social Security benefits in that spreadsheet? Back to betting on your own life expectancy I assume?) From Scott Burns:

The link to the CRR paper can be found at the bottom of this column: http://assetbuilder.com/?p=45. Economists generally calculate the value of an inflation adjusted life annuity to figure the value of Social Security benefits, commonly using long TIP rates as their benchmark internal return and, yes, they would use life expectancy figures. Economists like Jim Poterba at MIT and Zvi Bodie at Boston University have done a good deal of work trying to solve the risk/life income issue by searching for better life annuity solutions.

Thanks, Scott.

This was great stuff and I was impressed by both the quantity and quality of the email threads on your site that indicated how everyone else roughly my age is thinking about this and coming up with different answers than my simplistic "take the money and run." My wife and I are the same age so the formula and results would not be the same as the example you published in the Boston Globe 2/17 but the CRR paper roughly gives the methodology for figuring it out for us (something to do with whether her benefit is more or less than x% of mine).

On the other hand, the sons of guns took $180,000 from me over the last 40 years, much of it from back when a buck was worth something.   I don't know if I can wait just on principle………

Thanks again
February 17, 2007 6:10 AM

About scottb

Scott Burns has covered the changing world of personal finance and investments for nearly 40 years. Today, he ranks as one of the five most widely read personal finance writers in the country. Scott began his career as a newspaper columnist at the Boston Herald in 1977 where he was also the financial editor. Nationally syndicated in 1981 and now distributed by Universal Press, the column appears in newspapers from Boston to Seattle. In 1985 he joined the staff of the Dallas Morning News where his column quickly became one of the most widely read features in the paper. He left the Dallas Morning News in 2006 to become one of the founders of AssetBuilder and its Chief Investment Strategist. Burns is a graduate of Massachusetts Institute of Technology (1962). He has written four books, including "The Coming Generational Storm" (MIT Press, 2004) coauthored with economist Laurence J. Kotlikoff. His fourth book, also coauthored with Kotlikoff, will be published this spring by Simon & Schuster. "Spend Til' the End" uses consumption smoothing to demonstrate the errors of conventional financial planning. His business experience includes working as a staffer for a major consulting company and service as a director and audit chairman of a NASDAQ listed manufacturing company. He and his wife divide their time between Dallas and Santa Fe, New Mexico.
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