The Earnings Subject to Social Security Tax is Going Up Again!

The amount subject to Social Security Tax is going up again.

From a recent Social Security press release:

Some other changes that take effect in January of each year are based on the increase in average wages. Based on that increase, the maximum amount of earnings subject to the Social Security tax (taxable maximum) will increase to $106,800 from $102,000. Of the estimated 164 million workers who will pay Social Security taxes in 2009, about 11 million will pay higher taxes as a result of the increase in the taxable maximum.

Wages increased 4.7% in 2007? That’s a surprise to me.

Math-wise, the increase means that the maximum paid into Social Security in 2009 will go up to $6,622 from $6,324 (or, $13,244 from $12,648 if you include the employer-paid portion).

Take heart if you’re one of the 11 million workers shouldering this increase: you’re priviledged!

When Should You Begin Taking Social Security?

I received this information in an email from Jeffrey Voudrie, author of the website, Guarding Your Wealth. You can subscribe to his email newletter by clicking here (be sure and tell Jeffrey that JLP sent you). I highlighted the parts that I thought were important.

When To Start Social Security Benefits

Conventional wisdom and many financial planners say that you should start taking Social Security benefits as soon as you are eligible. For many, that is at age 62. This is another time that conventional wisdom may be wrong. Read on to see whether you should delay receiving those benefits.

A bird in the hand is better than two in the bush, right? There’s no guarantee that you will be able to catch the birds in the bush and you know that you already have a bird in hand. If that bird represents your next meal then you’d be a fool to let it go in hopes of catching several birds in the bush.

On the other hand, if you have enough birds in the freezer to feed you for several months it might be worth taking the chance on the multiple birds in the bush. Better yet, is there a way you could have both?

If the bird in question is your social security benefits, you may do better waiting for the birds in the bush. This is especially true if you have enough money in savings to meet your needs for the next several years. Even if it means spending down your principal to postpone the date you start benefits, you may be far ahead in the long run. You’d get the bird in hand and the ones in the bush!

On the other hand, if you aren’t able to meet your needs based on what you’ve set aside, than the bird-in-the-hand (taking benefits at age 62) is the better choice. Regardless of when you start Social Security payments, make sure you don’t delay receiving Medicare.

Conventional wisdom says that you should take benefits at age 62 because you can invest that money and earn a better return then Social Security does. We’ve all heard how the average return on the Social Security Trust Fund is only 1%, right? Wrong.

You can earn a guaranteed 8.25% per year by delaying when you start receiving benefits from age 62 to age 66. And it doesn’t depend on what the stock market does. It doesn’t matter what happens to interest rates.

Taking benefits at age 62 results in receiving only 75% of the amount you would get if you wait until you turn 66. Every year you wait, the amount you receive increases. By waiting until age 66, the annual increase averages 8.25% per year.

The average annual return you are guaranteed by waiting until age 70 is 10% per year. Benefits increase 8% every year past age 66. Waiting from age 62 to age 70 results in monthly payments that are 81% higher.

If you or your spouse lives beyond age 79 then you will be better off delaying benefits. Average life expectancies indicate that roughly 50% of those age 62 today will live beyond age 80. Medical advances will only increase that over time.

The risk of delaying benefits is that the main breadwinner may die prior to your breakeven age. That would still result in higher monthly payments to the surviving spouse who may live much longer. You can also use low-cost term life insurance to make up for the lost benefits.

Many of those retiring today have not set aside enough to provide for themselves and their spouse for the rest of their lives. Some face the prospect of draining their retirement savings and living just off of Social Security if they live beyond their 80’s. Even if you will use up your savings more quickly in the short-term, delaying the start date until age 70 could significantly improve your Social Security lifestyle.

There’s no way to tell with certainty what the best decision is for you because none of us know our life expectancy. If you think, based on your family history and present health that you will live beyond age 79 and you have enough assets to provide the money you need until age 65 or 70, then you may want to wait.

Some insurance companies recommend buying an immediate annuity to provide a payment equivalent to what Social Security would otherwise provide, but I don’t recommend that approach. Such annuities are expensive and cause you to lose control, access and flexibility of your money.

In addition to being a nationally syndicated columnist and Certified Financial Planning Practitioner, Mr. Voudrie provides personal, private money management services to clients nationwide. Read more financial and investment articles or get a personal response to a financial question.

This is definitely something to think about. Of course it’s still decades away for my wife and me but we’re planning to put off receiving Social Security as long as possible. It’s also our plan to not need Social Security in the first place since there’s really no guarantee that the program won’t be means tested by them.

How Much Could You Have if Social Security Was YOUR Money?

Imagine you were 22 when you started working back in 1978. Do you know how much money you would have if, instead of paying in the maximum Social Security tax over the last 30 years, you were allowed to keep it? It’s probably more than you think. Take a look at the chart below, which shows a 30-year history of Social Security:

30-Year History or Social Security

If you could have kept the maximum amount withheld for Social Security over the last 30 years and invested it at a 10% ROR it would have grown to over $418,000. Of course I used straight-line appreciation, so the actual amount would be quite different but this will work for comparison’s sake.

According to my calculations, the amount subject to Social Security tax has had an average annual increase of 5.85% through 2007, while the maximum tax itself has increased 6.58% over the same time period. The difference between the two numbers is due to the increase in the tax rate over the years.

30-Year History or Social Security

As I stated in the first sentence of this post, you were 22 when you started working 30 years ago, which would now make you 52 years old. If you continued to work and paid in the maximum amount into Social Security, how much could you have by the time you were 62? For 2008, the maximum Social Security tax is $6,324. If we increase that amount by the average annual increase of 6.58% for the following 9 years, it would look something like this:

30-Year History or Social Security

The forward-looking numbers are adjusted for inflation and assume a more conservative 8% ROR minus a 3% inflation rate. So, IF the money were yours to do with as you please, you could have over $789,000 by age 62. A 4% withdrawal rate would give you a first-year income of over $31,584 or $2,632 per month. I haven’t done enough research to know how that number would compare with a Social Security payout (that’s the topic of a future post).

An Observation

I think the past 30 years of Social Security history is NOTHING compared to what the future will be. I can only see more and more income being subject to Social Security tax because of the fact that we have the Baby Boomer generation retiring and fewer numbers of current workers to support them. So, the amount that my generation and the following generations will have to pay into the system will most likely be greater than the benefits received at retirement. That’s why I get so irritated everytime I see how much money is being sucked out of my paycheck to go into the blackhole we call Social Security. I know there’s not a snowball’s chance in hell that my wife and I will see the bulk of that money.

It’s really sad when you think about it. The program could have been so much better had we used to provide a safety net rather than giving it to everyone. It should have been based on need. Instead, everyone got benefits whether they needed them or not. Politicians didn’t care because there was an ample supply of Baby Boomers to fund current retirees’ needs.

Eventually our politicians are going to have to make some tough decisions.

NOTE: As Jeremy mentioned below, I left out the employer’s portion of the Social Security tax, which is equal to the amount the employee pays. When the employer’s portion is factored in, it really makes Social Security security look bad. Thanks for the catch, Jeremy.

A Hidden Benefit of Social Security

This from an article by Scott Burns I read today:

If you’re retired and are interested in having a higher income for as long as you live, you have two main options:

  • You can buy a life annuity. This will provide you with an income, with or without inflation adjustments, for as long as you live. But it will leave nothing for your heirs.
  • You can buy a variable annuity with a variety of living-benefit provisions. These will guarantee a lifetime income. The income will be less than a lifetime annuity, but you’ll have a modest chance of future increases, and you may leave something for your heirs.
  • Whatever you choose, the only thing certain is a lot of fine print.

    Fortunately, there is a simple alternative. It will work nicely for retirees in their late 60s or early 70s who had opted, years ago, to take Social Security benefits at a relatively young age. That’s millions of people.

    If you did this, you know that your benefits are a lot lower than they would be if you had waited and taken benefits later. Your benefits were reduced because taking benefits early meant Social Security would have to pay benefits for more years.

    But you can reapply from scratch with these easy steps. Visit your local Social Security office. Make use of a little-known and seldom exercised provision: Request a “withdrawal of application.” By filing SSA Form 521 (.pdf file), Social Security will treat you as if you had never applied for benefits. It will let you immediately reapply for benefits — at your current age.

    Yes, there is a catch. And it’s a big one. You must repay every dime you’ve received in past benefits. But because Social Security charges no interest, reapplying turns out to be a really good deal. It represents a way to buy an inflation-adjusted annuity for a price that beats anything offered by the financial-services industry.

    Read the rest of Scott’s article to find out the details. I had no idea this could be done. I hate to think what could happen to the system if lots of Boomers decide to do this.

    Social Security Wage Base Now at $102,000

    It just keeps going up…

    Last year (2007), the social security wage base—the amount of income that is subject to social security tax—was $97,500. For 2008 it is $102,000. Dollar-wise, here’s what it looks like:

    For 2007: $97,500 × 6.2% = $6,045

    For 2008: $102,000 × 6.2% = $6,342

    or, it’s 12.4% if you’re self-employed.

    Anyway, it works out to an increase of $297 or $594 if you’re self-employed.

    Just wait,… with all the Baby Boomers retiring over the next decade, I wouldn’t be surprised if both the rate and the amount subject to taxation goes up.

    I have never run the numbers but I have to wonder what the chances are of my wife and I ever receiving back what we paid in? When you consider the fact that $6,342 growing at 8% per year would be worth nearly $64,000 in 30 years, I would have to say it’s not likely that we’ll reap what we sow.

    If you’re interested, you can read more about the changes SSA.gov.

    Retiring Early? When Should You Start Taking Social Security Benefits?

    I took my kids to the library the other day. While I was waiting on them I took a minute to browse the business/personal finance section. I haven’t been in that section in a while because they never seem to have anything that is younger than 5 years old. I don’t know about you, but there doesn’t seem to be a lot of useful information in a personal finance book that is 5 years old. Anyhow, I came across a book that I remembered seeing in the bookstore recently and decided to check it out. It’s a book by Steven Silbiger and the title is Retire Early? Make the Smart Choices, which as you can tell, is about retirement planning. What I found interesting was the author’s discussion of Social Security and the things you should consider when deciding when to begin receiving benefits. It’s a tough decision and the answer isn’t always clear.

    In the introduction of the book, the author lists the seven key issues that affect the decision to begin taking benefits early. They are:

    1. What are the benefits available and what is the penalty for early retirement? What is the risk if you make the wrong decision?

    Most likely you can find out this information through your Social Security statement that you should be receiving once a year (usually before your birthday). The statement will show you what your expected benefit should be based on your retirement age.

    2. How’s your health? How long do you expect to live? How well is your spouse? What are the key health risks and how do they affect you?

    If you are in poor health, you might want to take your benefits sooner rather than later. The Social Security Administration’s website has a life expectancy table that you can use to give you an estimate of how long you could be receiving benefits. The table assumes you are 65 years old. They also have a break-even age calculator that will show you how much longer you would have to live before you break even by delaying benefits.

    3. Are you married? The early retirement penalty to the spouse could be 67 percent of the spouse’s benefits.

    4. Are you planning to continue to work while receiving benefits? If you work too much, you could lose out on a lot (or all) of your benefits.

    It’s crazy but if you begin receiving benefits before your Normal Retirement Age (NRA) but continue to work and you make over $12,960, you will lose $1 for every $2 of earnings in excess of $12,960. Ouch! And, according to the SSA.gov website, if you reach your NRA in 2007, you will lose $1 for every $3 of earnings in excess of $33,440 for the months prior to the month of your NRA attainment (thanks to commenter Dave for the clarification). The income amounts are indexed for inflation and therefore change yearly.

    5. What are your cash needs for retirement? Will your benefits be extra spending money or a major lifeline?

    If you don’t need the money, it makes sense to hold off receiving the benefits as long as possible.

    6. What forecast do you have for your own investments? Is having extra money now more important to you than more money later?

    It seems to me that this question is the same as number 5.

    7. How concerned are you about the projected insolvency of the Social Security system?

    There’s no sense in waiting if you don’t think the program is going to survive. However, if you are retirement age, put yourself in the shoes of us younger generations who are going to pay in a heck of a lot more in to the system than you did with even less of a chance of receiving benefits. Of course, I’m not complaining because I never had to go to war.

    So those are the key issues the author talks about. He then goes on to address each issue in broader detail. The first chapter of the book is worth the price of the book becuase of the way the author walks step-by-step through an example of how he helped his friend figure out which path was best for her. This is a great topic that I hope to research and post on further.

    Good Article on Social Security

    I’m busy today but I wanted to share this article that I found in the June issue of Financial Planning with you. It’s titled The Greatest Benefit and it is about how planners can help people understand and plan for Social Security benefits. It’s a very complex issue (much more complex than it should be) since the benefit amounts are based on several factors:

    • The income you received during your lifetime and the social security taxes you paid in.
    • The age at which you begin taking benefits. The longer you put it off, the bigger your benefit is up to a point.
    • Your marital status at the time you take benefits. Do you want your spouse included in your benefits or do they want to take their own benefit?
    • Whether or not you work during retirement. If you work and make too much money, you’ll have to give up some of your social security benefits.
    • Taxation of benefits. If you have too much income from other sources during retirement, some of your social security benefits will become taxable.

    So there’s a lot to consider. The article does a decent job of explaining some of these decisions from a planner’s point of view.

    Personally, I don’t like social security. When I look at the amount of money that my wife and I are paying in, we could EASILY have an additional $1 to $2 million at age 70 if we were allowed to invest the money on our own (and that’s not including the employer’s portion of the contribution). Something tells me that we’ll never see benefits that good. The government is a poor money-manager.