Have you ever said or heard someone say, “I’ll never get the money back that I paid into Social Security!”? Or, “I wonder how many years it will take me to just get back the money I paid into Social Security?” Usually, these questions are followed by the irreversible decision to take Social Security early. So, before you do that, read to the end of this article.
Now, to begin to answer the questions above, we have to know what paying into Social Security looks like. If you receive a paycheck, you will see an employee tax for OASDI (Old Age, Survivors, and Disability Insurance) listed on your pay statement. This is what most of us refer to as Social Security tax, i.e. what we are paying into the system.
Let’s look at a hypothetical example
The Social Security full retirement age (FRA) for those born between 1943 and 1954 is 66. Mary was born Dec. 7, 1953. She became a tenured professor of chemical engineering on Jan. 1, 1985. Since that time, her salary has equaled the maximum subject to the OASDI tax. She retired at the end of 2019 at her FRA of 66 and began receiving Social Security benefits in January 2020.
Since 1990 the employee contribution rate has been 6.2%. The only exceptions were in 2011 and 2012 when Congress approved a temporary rate reduction to 4.2% as part of the Great Recession tax relief package. So, Mary’s maximum earnings subject to OASDI taxes of 6.2% (or 4.2% in 2011 and 2012) would have increased from $39,600 in 1985 to $132,900 in 2019. You can see the table here. This means Mary would have paid $175,567 in OASDI taxes. The maximum FRA benefit for 2020 is $3,011 per month or $36,132 per year. Assuming no cost of living adjustments, she will recover the taxes she paid in 4.86 years, before she reaches age 71, and the benefit continues for the remainder of her life.
OK, that’s pretty good, but what if instead of paying OASDI taxes, Mary put the same amount into an investment account each year, earning 5% annually. At retirement, Mary would have had $485,571. For this analysis, the investment account will continue to make 5% with an annual withdrawal of $36,132 (Social Security Benefit) with a 1% annual cost of living adjustment (COLA). Her investment account is depleted a few months shy of her 86th birthday.
That looks pretty good; you might say even better than Social Security. However, it depends on making a 5% return every year for 55 years. It also depends on Mary consistently saving the required amount each and every year. Both of those could be big ifs.
But wait! Mary has been married to Cal for 38 years, and he has been a stay-at-home husband and father most of those years. He is also age 66 but has very few years of Social Security earnings. He is eligible for a spousal benefit on Mary’s account for one-half of her FRA benefit. That’s another $18,066 per year, bringing the total annual benefit of Social Security to $54,198. Including the spousal benefit (1% COLA) in the analysis, the investment account runs out at Mary’s age 77. That’s not so good if Mary lives longer.
With Social Security, if Mary should die at age 77 and Cal is still alive, he will receive Mary’s full Social Security benefit for the rest of his life. That’s a pretty good deal! Of course, not everyone is as lucky as Mary to have earned such a high salary over the course of her career. Each family has a unique combination of earnings between spouses.
Will Social Security even exist when I retire?
There is a lot of speculation about Social Security’s solvency in the media. One important thing to remember is that challenges to the Social Security system do not equate to a total failure of the system. In April 2020, the Social Security Board of Trustees’ annual report on the state of Social Security Trust funds projected that the trust fund’s combined asset reserves for retirement and disability benefits will be depleted in 2035. BUT, that doesn’t mean there won’t be benefits! The continuing payroll tax income would be sufficient to pay 79% of scheduled benefits in 2035 and 73% by 2094.
Of course, this was the case before the lingering effects of COVID-19. Issues brought on by the pandemic that could cause the trust funds to be depleted earlier and potentially reduce payments going forward include the following:
- Payment of Social Security benefits are dependent on current payroll taxes paid by both employers and employees. High unemployment and underemployment reduce the taxes available for current payments.
- Older unemployed and underemployed workers might decide or be forced to retire and claim benefits earlier than planned, increasing the funds needed.
The Federal Reserve keeping interest rates at all-time lows reduces the income from bonds held in the trust fund reserves.
As you can see, a number of unknowns exist regarding the future of Social Security. Included in our financial planning services to clients, we analyze the optimum Social Security strategy (combined with pensions if applicable and other savings) for your specific needs.
Give us a call if you would like some help with your Social Security planning.
Post written by Peggy Sherman, CFP®. She joined our team in 2007 and has expertise in Social Security and Tax Planning. Learn more about Peggy here.