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The Impact of Future Earnings on Social Security Benefits

Q: A recent column of yours answered an important question about Social Security. The annual statements regarding retirement payments are in constant dollars. Another question not addressed in those statements is: How does the amount of future earnings (and Social Security tax contributions) affect my projected monthly benefits?

My statement says I am already qualified. It also says that if I retire at the full retirement age of 66, I will receive $1,926 a month. 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. I don't pay anything near the maximum amount (based on $94,200 in earnings) in Social Security taxes now, as I did 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? -- A.M., via e-mail

A: If you suffer a reduction, it will probably be modest because of the way Social Security benefits are calculated. Social Security isn't a genuine retirement program that provides benefits in direct proportion to the amount of taxes received. It is a program to provide some level of retirement income to all workers. Benefits are disproportionately greater for lower-wage workers.

If you visit www.ssa.gov/OACT/COLA/piaformula.html, you can read about how benefits are calculated. Workers receive three levels of crediting for their wages:
  • Monthly wages below $680 (for 2007) are credited at 90 percent.
  • Monthly wages over $680 but below $4,100 are credited at 32 percent.
  • And monthly wages over $4,100 a month are credited at only 15 percent.
So wages over $4,100 a month increase your benefits one-sixth as much as wages under $680 a month.

This formula is the reason lower-wage workers can expect to see a relatively large part of their earnings replaced at retirement. Minimum-wage workers, for instance, can expect to receive about 60 percent of their work earnings in retirement, average workers can expect about 42 percent, and highest-wage earners (those at the $94,200 wage base cap for 2006) can expect about 27 percent. (A table of estimated future values is in the 2006 Social Security Trustees Report at www.ssa.gov/OACT/TR/TR06/VI_OASDHI_dollars.html#wp120186.)

In effect, the Social Security benefits formula is a steeply graduated tax on retirement contributions. The greater your wages, the smaller the benefit you will receive back for each dollar of employment tax payment.

For you, this means a period of lower earnings won't have as large an effect on your future benefit as you would think.   

Q: I recently bought several exchange-traded funds --this after having owned mutual funds for some time.

Mutual funds are valued at the end of the day at the net asset value of the equities owned by the fund. My question: Is the value an ETF is listed at and trades at related to the value of the equities held by the fund? Or is it a value that buyers and sellers agree to make a trade of the fund shares at that is otherwise independent of the value of the equities held by the fund? -- B.J., via e-mail

A: Exchange-traded funds, like closed-end funds, may trade at a discount or premium to the underlying value of the fund portfolio. Unlike closed-end funds, however, the discounts or premiums tend to be quite small for a number of reasons. Recently, for instance, the pricing of the iShares S&P 500 index ETF had ranged from a 0.20 percent premium to a 0.30 percent discount.

Premiums and discounts may become a material issue as the number and variety of ETFs increases, but the major ETFs (as opposed to the obscure ones) enjoy robust trading and tight pricing.
Published Dec 06 2006, 06:00 PM by scottb
Filed under: ,

Comments

 

ABModerator03 said:

I am in much the same position as the retiree. I was told that in the October of the year that I retire with full benefits(January 2007) that SS will review my earnings for my final year (for which SS has no tax return) and change the benefit if my final years earning are more than an earlier year (in constant dollars). If my benefit increased, it would be retroactive. I am not aware that earnings after I begin receiving full benefits would be affected.

  

From Scott Burns:

Another thing that might happen by working an additional year is that your current year earnings may displace an earlier year of earnings IF the current year earnings are higher. Your final benefit is determined by your 35 highest years of earnings.
December 7, 2006 7:09 AM
 

ABModerator03 said:

Scott, in your answer today about social security you failed to point out that the man's earnings could be a lot lower now that he is not "working for corporations" and yet his social security benefits could still go up every year.

That is because they use a 35 year rolling average, correct?

What if his first 3 years were in summers during high school, and he only made $1,000 or 2,000/year then? Or maybe he started his first real job making only $8,000/year like me. So now, when those rolling 35 year periods scroll through, he may replace a low salary from high school (of $1000)--with, say, a low salary of today--say, $20,000---and get good benefit from that.

Is my thinking correct?

Kenny

  

From Scott Burns:

It's almost correct. The process you outlined is what happens BUT wages are indexed. So the $8,000 from long ago may now have an adjusted value of $40,000. If his current earnings are higher than some of his old inflation adjusted earnings it is very possible that his benefits could increase because your benefits are based on your HIGHEST 35 years of earnings.
December 8, 2006 11:32 PM
 

ABModerator03 said:

As a person who earned more than the SS limit for many years before retirement, I was surprised to learn that more years of work wouldn't change my future benefit at all. I used the SS calculator http://www.ssa.gov/retire2/AnypiaApplet.html to put in my historical earnings....
December 10, 2006 10:45 AM
 

ABModerator03 said:

Dear Scott, I really enjoy reading your column. I have a question regarding my Social Security. In early January 2006, I took a withdrawl from my IRA to pay some bills. I did not start getting a Social Security check until June 2006. Do these IRA funds count against my Social Security, even though I was not on Social Security at the time. Thank you in advance for your help.

Bill

From Scott Burns:

Withdrawals from IRA plans count as ordinary income and must be included in your tax return. If those withdrawals are high enough they will trigger the inclusion of up to 85 percent of your Social Security benefits in your taxable income.

This is a good subject to visit with an accountant about.
December 15, 2006 9:07 AM
 

ABModerator03 said:

Hello Scott,

I'm in sort of a "Catch 22" situation. I began collecting full Social Security benefits at my appropriate age, which in this case was at 65 plus 6 months. At the time I was out of work, with no prospects in sight and it was what I had to do. Not too long after that I secured part-time work which I have been doing for about a year and a half. I found out that my job is being eliminated at the end of this month, and I have been seeking other part-time work, but have not found any as yet. My current employer does have a full time position available which I can apply for, and working fulltime would allow me to pay off accumulated debt and make substantial payments to my IRA's. I contacted Social Security and asked if it was possible to "suspend" my Social Security payments and go back to work full time. I was told in order to do this I would have to repay everything I collected so far in Social Security benefits in order to suspend them at this point and start them up at a later date. That, of course, is out of the question.

My question is this: I collect about $1353.00 a month in Social Security, but that is not enough for me to live on. Do you think I should take the fulltime position if it's offered and bite the bullet tax-wise for about 2 years, or just continue to seek a part-time position to supplement the Social Security I have now. Would Social Security reduce my payments anyhow once I reached a certain income amount?

I know I have a lot of questions, but I really need some answers before I proceed with taking this full time job if it's offered.

Thank you again,

Lyda

From Scott Burns:

Having started Social Security at your full retirement age, you don't have to deal with the income limitations of those who retire early--- between age 62 and full retirement age. You will, however, have to pay FICA taxes on your earned income and it is possible that your work earnings will trigger taxation of some of our Social Security benefits. But working a few more years also has some nice advantages.

First, it will allow your existing investments to grow for a few more years. Second, it will allow you to add to your retirement savings, perhaps quite generously since you are receiving SS benefits. And, finally, Social Security will automatically recalculate your retirement benefit to see if the additional work will increase your benefit. While you won't pick up the actuarial increase for delaying benefits, if your new job earnings improve your earnings record, your future benefits will increase. Your current benefit is based on your 35 best years of earnings. If you have a few years out of the work force or a few years of very low wages, your additional years of earnings may work to increase your benefit nicely.
January 12, 2007 9:08 AM
 

ABModerator03 said:

Conceptually, some retirees would prefer to defer SS benefits and leave the benefits to their children. In my case, the benefit could be deferred for about 30-33 years. This is equivalent to me living to age 95, which is not possible. It might be the subject of an article. I recognize, at this time, there is no mechanism available to pass-through the benefit to the next generation.

Stephen

From Scott Burns:

  Interesting idea. Unless you have a life-threatening medical condition, there is about a 3 percent chance that you could live to age 95, if I recall the numbers from the Life Tables correctly.  
February 19, 2007 12:22 PM

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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