Welcome. You’re listening to the FinTrust Capital Advisors From The Desk Of Podcast: our podcast about markets, life, and things financial. Today’s podcast about social security is a three-part series featuring FinTrust financial planners, Mary Katherine (MK) and Cassidy Murphy.
MK: Hello everyone, and welcome to this week’s episode of from the Desk of, our podcast about markets, life and all things financial. My name is Mary Katherine Glassman. And today I’m joined by my colleague, Cassie Murphy. We are both financial planners with FinTrust Capital Advisors, and today we will be discussing a government program that pays over 1 trillion in total benefits to over 69 million Americans every year. That’s right, Social Security. Since we try to keep these podcasts relatively short and sweet, we’ll be delving into this topic as a three-part series covering Social Security basics: filing strategy decisions and answers to some of the most common questions we receive.
Cassidy: Yes, and Social Security is a very complicated program with a lot of nuanced rules. So we’re going to try and keep our scope pretty narrow in each of these episodes. But to start out, let’s back up a little bit and dive deeper into how your Social Security benefit is calculated and where that money comes from. Social Security is primarily funded from a payroll tax, and that’s paid by most employees, employers, and self-employed workers. The current tax rate is 12.4%, which is paid half by workers and half by employers. Or if you’re self-employed, you probably know that you pay all of it. That tax is applied to your wages up to a certain limit every year. And for 2022, you’re only paying that tax on wages up to $147,000. Now, to become fully entitled to receive Social Security benefits, you need to pay those taxes for a total of 40 quarters of work. In reality, it’s a little more complicated than that, but for the sake of simplicity, we’re just going to say that you need 40 quarters of work to receive benefits. Now, MK, do you want to talk to us about where all that tax money goes?
MK: Sure. So about eighty-five cents of every Social Security tax dollar goes to a trust fund that pays monthly benefits to retirees, their families and survivors and the other $0.15 goes to a separate trust fund that pays benefits to people with disabilities and their families. So basically, current workers are paying taxes into the program to support current retirees who are taking the benefits out. Where things get a little dicey is that when the program was first designed, there were around 160 workers paying into the system for every one retiree collecting benefits. So, for quite a while, the trust fund was taking in more money than it was paying out, so it accumulated a pretty large cash reserve. However, over time, that trend has reversed to the point where there are now only about two eight workers paying taxes for every one retiree taking benefits. The trust fund now runs at a deficit, meaning it pays out more in benefits than it generates from taxes and interest.
Cassidy: Exactly. And this is what people are talking about when you see headlines about Social Security or the trust fund running out. And what that means is that if no changes are made to the program, such as raising that taxable wage base, raising the tax itself, or pushing full retirement age out further than the trust funds, excess reserves will run out and the program will only be able to pay out as much as it’s taking in, which should cover about 75% of benefits. Now, whether that happens or not remains to be seen, and we obviously don’t have a crystal ball, but Social Security has strong bipartisan support and it’s incredibly popular among voters. So, I think it’s safe to say that there will be some sort of changes made at some point in the next ten years that will improve that outlook and shore up the program. But worst-case scenario, if absolutely nothing is done in the meantime, benefits could eventually be reduced across the board by about 25% if the trust fund does run out in the mid-2030s.
MK: So, we’ll be optimistic for now and assume that doesn’t happen and Congress eventually steps in to fix things. In which case, when we talk about these benefits being paid out, how is each person’s benefit calculated? What factors influence how much money a retiree gets from Social Security each month?
Cassidy: Well, your benefit amount mostly depends on your earnings history. And what they do is they start with your highest 35 years of earnings. And remember, you only pay Social Security taxes on earnings up to a certain amount each year. So those are the only earnings that they care about. You don’t get credit for anything above that, but they take those highest 35 years of earnings, they index them for wage inflation, and they come up with a monthly average for what you earn over that time. That average amount then goes through a formula that uses what are called bend points that are designed to replace a greater proportion of income for lower earners. So, if you averaged under $15,000 a year, Social Security is designed to replace about 75% of that in retirement. But if you were at the highest ends of the income limits, it’s only going to replace more like 25%. But that’s how they come up with what they call your primary insurance amount, which is what your monthly Social Security benefit will be if you file at your full retirement age. And your full retirement age depends on when you were born, but it’s somewhere between 66 and 67.
MK: Interesting. So, what happens if you have less than 35 years of earnings? Do they just average out however many years you do have, or do they factor zeros into that calculation?
Cassidy: Now, unfortunately, they will give you zeros for years where you had no earnings if you have less than 35 years paid into the system. So that can be something that’s important to consider for people that are looking to retire early and may end up with multiple years of zeros figured into their formula. Because of the way they rate the formula, it doesn’t always have a big impact, but it’s not nothing.
MK: Okay, and circling back on what you said about past earnings being indexed for inflation, is that the cost-of-living adjustment that we’re seeing in the headlines lately? Is everyone going to end up getting almost 9% cost of living adjustment for this year factored into their current or future benefit?
Cassidy: Now, that’s a question that we’re seeing a lot of lately. And if you turned 62 or older this year and you’re eligible for Social Security benefits whether you filed or not, the answer is yes. If you’re under 62, the answer is no. And why that is, is that up until age 60, your past earnings are indexed based on the national Average Wage Indexing series. After 62, your primary insurance amount is adjusted for inflation each year based on the CPI-W. And that’s where the almost 9% number is coming from. So, in other words, benefit adjustments before age 60 are based on wage increases, and adjustments after 62 are based on price increases. And then there aren’t any adjustments made between 60 and 62.
MK: Got it. Thank you. So that’s all we have time for today. In the next episode, we will continue our Social Security discussion and we’ll get into filing strategies and other considerations. But in the meantime, and time, if you have any questions about what we’ve talked about today or want us to dive deeper into the specifics of your own financial situation, please reach out and we’re happy to help. Thank you all for listening.
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