If you’re planning on relying solely on your social security check for retirement, you may want to reconsider. Here’s why.
The federal government ushered in a slew of progressive programs during the Great Depression with the aim of helping the most downtrodden Americans. And few of these programs have held the progressive banner higher than Social Security.
“Social Security was designed to redistribute income from those with higher lifetime earnings to those with lower lifetime earnings,” the Urban Institute once wrote in a paper. “The reason is obvious: The system was created to ensure an adequate retirement income for the elderly.”
Social Security clearly has helped to alleviate poverty in old age and has proven to be highly popular, up and down the political and socioeconomic spectrum. But in reality, the program isn’t quite living up to its progressive design.
The debate over Social Security’s progressive features, or lack thereof, has been going on for years. What piqued my recent interest were some new commentaries. For example, the Investment Company Institute, a mutual-fund trade group, asserted that Social Security is indeed progressive. It labeled arguments to the contrary as a “myth.”
Social Security has a progressive design, the group noted, because these government-paid benefits replace a much higher percentage of working-year earnings for lower-paid Americans, especially considering that low earners pay less in Social Security payroll taxes over their lifetimes.
Social Security replaces a proportionately lower amount of working-years income for high earners. Instead, these people gain more from the tax-deferral aspects of Individual Retirement Accounts, workplace 401(k) plans and the like.
Eroding the progressive design
But there are factors at work that make Social Security less progressive than it was intended to be. Many of us know somebody who died before receiving any Social Security benefits. This concern prompts a lot of people to claim benefits shortly after turning 62, locking in monthly benefits at the lowest level.
Poorer people tend not to live as long as wealthier Americans, for various reasons. Consequently, they often lock in lower monthly benefits by claiming early and don’t receive payments for as many years. Plus, Social Security benefits are partly based on earnings, so monthly payments will be lower anyway for people who didn’t earn as much over their lifetimes.
This was the gist of another recent paper, from the Center for Retirement Research at Boston College, which noted that while life expectancy in older ages has been rising, “these gains have been unequal across the population.”
In particular, less-affluent Americans “have seen relatively small improvements in their late-life mortality” and that “works against the progressive benefit design of Social Security,” the report said.
And many other factors affect how much money people receive from Social Security. Some are progressive but others are regressive, favoring (or at least not hurting) wealthier individuals.
For example, Social Security benefits are capped, at nearly $2,800 per month for 2018. This means a billionaire like Jeff Bezos won’t receive any more than a middle manager. That’s a progressive feature.
Conversely, what you receive in Social Security benefits is partly based on how much you earned over the years in income, and how much you paid in payroll taxes. But the tax rate itself — 6.2 percent, levied on both employers and workers — is a flat tax that doesn’t rise as people earn more. This isn’t a progressive feature.
Social Security benefits can become partly taxable for people who have other income such as sizable withdrawals from an IRA or 401(k) plan. Affluent Americans are more likely to have these accounts and thus are more likely to trigger taxes on Social Security benefits. That, too, is progressive.
In short, the income-replacement feature of Social Security is progressive. But tax and other aspects muddle the picture.
Impact of disability
Social Security isn’t just a retirement program. It also makes payments to disabled workers and to the dependents and survivors of Social Security participants — and these recipients often are people who earn little, if anything.
“Disabled-worker and auxiliary benefits together account for only about a quarter of total benefits, but they account for most of the differences in the benefit-to-tax ratio across the earnings distribution,” said a report by the Congressional Budget Office. In other words, the system, including disability and other benefits, is more progressive than if you focused on the retirement side alone.
And there are other ways to evaluate the system. The Urban Institute, among others, has concluded that “less-educated, lower-income and nonwhite groups benefit little or not at all from redistribution” effects of Social Security.
But it found that women, who historically have earned less than men, do see gains. The program redistributes money from men to women, often as spousal survivor benefits. The report added that single women don’t fare as well as married women in this regard.
Tips for retirement success
Against this backdrop, various reform proposals could make Social Security more progressive, and solvent, such as raising the wage-base cap, which limits the amount of income on which payroll taxes apply (the current limit is $128,400 for 2018).
But lower-income workers concerned about retirement shouldn’t wait for reform. Rather, they should take steps to improve the odds of receiving higher income from both Social Security and private retirement plans. These include:
- Delay Social Security benefits if you can past 62 (the age you can first claim them). Benefits rise about 8 percent each year you wait, up to age 70.
- Work longer, if you can. Staying employed even a few more years, and delaying Social Security, are among the most significant steps you can take.
- Contribute more money to workplace plans for which you are eligible. At a minimum, invest enough to snag any matching funds offered by your employer.
- Open an IRA if you don’t have a retirement plan at work. In general, IRA contributions are deductible if you don’t have workplace access. If you do have a workplace plan, IRA investments still might be deductible if your income is modest.
- Utilize the retirement saver’s credit, a federal tax benefit worth up to $2,000 ($4,000 for joint filers) to help low-income people afford IRAs or 401(k) plans.
- Beware taxes when pulling money from IRAs or 401(k) plans. Regular taxes plus a 10-percent penalty (if under age 59 1/2) can erode your assets. Withdrawals also can make Social Security benefits partly taxable if you have started to receive them.
Reach Wiles at email@example.com or 602-444-8616.
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