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THE PERPLEXING WORLD OF SOCIAL SECURITY AND
EARNINGS IN RETIREMENT
Launched in 1935 during the Great Depression as a principal
component of Franklin D. Roosevelt's New Deal recovery program,
the Social Security System has earned an unquestionable
reputation for the reliability of its stream of monthly checks
to retirees, the nation's first comprehensive source of
retirement income.
But did the laws that authorized the checks and ensured their
reliability also:
- Permit the
checks — based on your lifetime income — to be large enough to
sustain seniors in comfortable retirement?
- Require Social
Security checks to be taxed too much by the same Treasury
Department which issued them?
- Reduce the checks
too severely for those who needed money before becoming 65?
- Enable
beneficiaries to get back all of the money they had paid
into the system over the years?
While these questions — and the question of the system's
continuing reliability as the ratio of beneficiaries to taxed
active workers increases — are debatable and debated by lawmakers,
the most baffling for many individual workers as they plan for
the approach of retirement is: when do you start receiving
Social Security checks?
The answer, partly rooted in changing regulations, is not
easy. Nor is it the same for all individuals.
Yet, it is very important. On it depends not only when you
start to receive checks, how large your checks will be — the
earlier you start, the smaller your checks — and how much you may
earn from other work once you start, but also how much net
Social Security income you will have left after income taxes.
To understand how these things are determined, you first have
to understand the regulatory concept of your "normal
retirement age" (also called your "full retirement
age") at which your retirement benefits equal your
"primary insurance amount." For those born in 1937 or
earlier, it is 65. For those born in 1960 or later, it is 67.
For those born in 1938 through 1959, it is in-between. (Useful
tables which spell out this and other relevant regulations
appear on the Social Security Administration's web
site, www.ssa.gov).
If you decide to start withdrawing Social Security before
your "normal" retirement age, you may retire as early
as age 62, but your benefits may be reduced as much as 30
percent if you were born after 1959 or 25 percent if you became
62 in 2005 — a reduction that shrinks your monthly checks
permanently.
If you decide to defer getting Social Security past your
"normal" retirement age (delayed retirement credits),
your benefits may be increased by percentages depending on when
you were born: from 3 percent if you were born in 1917-1924 to 8
percent if you were born in 1943 or later. You would receive
your largest benefit by retiring at 70.
Whatever the SSA determines you should get monthly (to be
further adjusted annually for inflation unlike most private
sector pensions) may be (further) reduced if you get work for
pay before you reach your "normal" retirement age: $1
in benefits for each $2 you earn above an annual limit. Last
year, that limit was $12,000; this year, it's $12,480. In the
year you will reach "normal" retirement age, the
reduction is less — $1 in benefits for each $3 you earn above
$33,240 in 2006, until you reach the point at which you can earn
all you are able to without penalty. This point is reached once
the recipient arrives at their normal retirement age.
For example, a retiree with earned income of $25,000 and a
Social Security benefit of $1,000 per month would receive just
$478 each month after a reduction due to earnings. Done with the
SSA, you now emerge on the radar screen of the Internal Revenue
Service, which is required to get its share and finds you an
especially fertile target if you have substantial income beyond
Social Security. An SSA web site calculator helps you to
understand how the earnings test would apply to you.
If you are filing a federal income tax return as an
individual and have "provisional income" —
defined as
adjusted gross income plus nontaxable interest (such as interest
from tax-exempt bonds and income dividends from municipal bond
mutual funds) plus 50 percent of your Social Security benefits —
between $25,000 and $34,000, you may have to pay income
tax on that 50 percent. If your combined income exceeds $34,000,
up to 85 percent of your benefits may be taxable.
If you file a joint return and you and your spouse have
provisional income (as defined above) of between $32,000 and
$44,000, you may have to pay tax on 50 percent of your Social
Security benefits. However, up to 85 percent of your benefits
become taxable when your combined income exceeds $44,000. This
is a complex rule, so consider contacting the Social Security
Administration or your tax adviser for more information.
March 2006 — This column is produced by the Financial
Planning Association, the membership organization for the
financial planning community, and is provided by Don McCarty of
Financial Decision Partners, a local member of the FPA.
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