As financial planners, we often help people decide when to start receiving Social Security benefits. We evaluate options seeking to optimize the amount of income withdrawn over the remainder of someone’s assumed life expectancy.
Few people focus on how to optimize Social Security income, however. The majority of people accept a permanently reduced benefit by claiming Social Security before their full retirement age. What many people want to know is: Will I receive more money back in Social Security income than I paid into the system via taxes over my working lifetime?
New research from the Urban Institute provides general answers to this question. In most cases, it is unlikely that you will receive Social Security income that exceeds the net present value of the money you paid into Social Security. However, you are likely to receive benefits from Medicare that exceed what you paid into that system via payroll taxes.
Variables such as when you retire, whether or not you are married and of course, your lifespan, create some variance in the outcomes. The Urban Institute report shows estimates of lifetime value for Social Security and Medicare based on a typical worker across multiple generations at various earnings levels.
If you turn 65 in 2010 or later, it’s less likely that your Social Security income will exceed your contributions. Earlier generations were more likely to come out ahead.
Personal finance writer Liz Weston makes a noteworthy point that people shouldn’t focus on Social Security in terms of providing an investment return on the money they paid in taxes.
“Social Security isn’t an investment scheme,” Weston wrote. “It’s insurance. (The formal name for what we know as Social Security is Old Age, Survivors, and Disability Insurance or OASDI). It’s insurance against poverty, against outliving your assets, against a downturn in the market at the wrong time that could leave you with too little money on which to live. You still should save and invest as much as you can on your own, but Social Security provides a safety net in case things don’t go as planned.”
Many people are concerned that the future of Social Security is problematic. There is a media-driven assumption that within 20 years, Social Security will be bankrupt. While future Social Security income could be significantly challenged by an aging population – with more people receiving benefits than are paying taxes into the system – it is not an all-or-nothing scenario. Even without any adjustments to the way Social Security is funded, there will be enough workers to provided Social Security recipients with about 75% of their currently expected benefits. Likely, there will be adjustments, such as increasing the eligibility ages or taxing income at higher levels, which could maintain expected Social Security income.
The Social Security problem is essentially solvable. The challenge of funding Medicare is much more dire.
The Wall Street Journal used this example in the Encore section of its December 8 edition.
A one-earner couple with a high wage ($71,700 in 2013 dollars) retiring in 2015 can expect lifetime Social Security benefits of $640,000. The same couple can expect to get $427,000 in lifetime Medicare benefits—while paying only $111,000 in Medicare taxes.
It’s the Medicare system that needs extensive reform to avoid bankruptcy. So don’t be surprised to see Medicare taxes and premiums rise. For many people, since Medicare payments are withdrawn from Social Security checks, this effectively is a form of reducing Social Security income.
~ Gary Brooks, CFP® — Brooks, Hughes & Jones Wealth Advisors – Tacoma, WA