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Retirement Planning and Employee Benefits for Financial Planners

Chapter 11: Social Security

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Benefits Available Retirement Benefits Disability Benefits Family Benefits Survivors’ Benefits Medicare Supplemental Social Security

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Social Security Inadequate funding of Social Security

Ratio of workers to beneficiaries 1950 16:1; 1960: 5.1 to 1; 2004:3.3 to 1, 2025:2.3 to 1

Currently 55 million getting $1,077 average monthly check

Retirement life expectancy 1935: 65 to receive benefits; life expectancy 62

years 2008: benefits as early as 62, life expectancy 80+

Number of workers Where’s the money?

Used to pay current benefits Excess invested in $1.5 trillion in Treasury bonds

Surplus projected until 2017

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Social Security

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Social Security Inadequate funding of Social Security

2010 report of trustees Social Security will exhaust funds in 2037 Will only be able to pay 75% of benefits

Solutions Increase taxes by 2.15% Tax all wages Immediately reduce benefits 14% Make $5.3 trillion contribution to trust fund Keep COLA at inflation – 1% (eliminates 75% of shortfall) Raise retirement age to 70 (eliminates 33% of shortfall)

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Social Security Inadequate funding of Medicare

2010 report of trustees Medicare will exhaust funds in 2029

Solutions Increase taxes by 1% Immediately reduce benefits 17%

7 Social Security Taxes and Contributions Federal Insurance Contributions Act (FICA)

Collected through payroll taxes Total taxes of 7.65%

6.2% up to $110,100 of compensation (OASDI) 4.2% in 2012

1.45% of total compensation (HI) An additional .9% HI for compensation above $250,000 MFJ

beginning in 2013 Unearned income above $250,000 MFJ is subject to a 3.8% HI

tax beginning in 2013

OASI Trust Fund 5.30% up to $110,100 (2012)DI Trust 0.9% up to $110,100 (2012)HI Trust 1.45% (all compensation)SMI Trust Funded by general tax revenue

8 Qualifying for Social Security Benefits

Fully Insured 40 quarters of coverage

A quarter of coverage = $1,120 for 2012 of earnings

Maximum accrual of 4 quarters per year Currently Insured

6 quarters of coverage out of the previous 13 quarters

9 Qualifying for Social Security Benefits

Not covered by Social Security Family employees

Child under 18 Not in trade or business

Railroad employees Ministers

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Social Security Beneficiaries Participant Worker Participant’s Spouse Participant’s Children Dependent Parents Workers Divorced Spouse (10+ Year

Married)

11 Social Security Retirement Benefits Retirement benefit payable at retirement

Fully Insured Retirees Normal Retirement Age is increasing

Currently 66 years. Will increase to age 67 in 2027

Increased benefit for delayed retirement Retirement BEYOND normal retirement age

Decreased benefit for early retirement Retirement BEFORE normal retirement age

Monthly benefits increase each year based on COLA

12Calculating the Retirement Benefit (1 of 3)

Calculate the worker’s Average Indexed Monthly Earnings (AIME) Convert earnings after age 21 to current

dollars using an indexing factor. Earlier earnings, higher factor

Sum the highest 35 years Divide sum by 420 months

13Calculating the Retirement Benefit (2 of 3)

Calculate the worker’s Primary Insurance Amount (PIA) Sum of three separate percentages of the AIME

90% of the first $767 (2012) 32% of the AIME over $767 and less than $4,624

(2012) 15% of the AIME that exceeds $4,624 (2012)

Consequently, workers with lower income will receive a much higher percentage of their wages in social security benefits Low income workers: social security 60% of

retirement income

14Calculating the Retirement Benefit (3 of 3)

Worker would receive PIA. Maximum PIA = $2,461 (2012) A beneficiary of the worker may receive a

percentage of the PIA: Spouse w/child under 16: 50% Spouse, age 65: 50%

Spouse can receive benefits based on her PIA if it is greater

Spouse, under age 60: none Child under 18, 50%

15Calculating the Retirement Benefit (3 of 3)

Deceased worker A beneficiary of the worker may receive a

percentage of the PIA: Spouse w/child under 16: 75%

In general, must be married nine months at time of death but exceptions to rule exist

Spouse, age 65: 100% Spouse can receive benefits based on her PIA if it is

greater Spouse, over age 60,: 71.5% Child under 18, 75%

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Early Retirement May begin at age 62. Permanently reduced benefit:

Currently receive 75% of normal retirement benefits But nearly 50% elect to retire at age 62 Almost 70% elect to receive benefits before

normal retirement age By 2027, receive only 70% of normal retirement

benefits Journal of Financial Planning, Jan. 2004

Breakeven generally occurs at age 73-74 70 – 80% likelihood of someone age 62 living to age

74

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Delayed Retirement Begin taking retirement distributions after normal retirement

age. Permanent increased benefit.

Increases the benefit by 8% for each year of delayed retirement from normal retirement (age 65, 10 months) until age 70.

Consequently, benefits increased by 32% if wait until age 70 to begin collecting benefits Consequently, often recommended strategy

Higher income spouse delay until age 70 Increase his suspended benefits, but spouse can draw 100%

normal retirement benefits Lower income spouse take at age 62

Switch to spousal benefits at death of spouse

18Retirement Earnings Limitations Test (1 of 2)

Social Security Retirement benefits are reduced for early-retirees who have earnings from continued employment.

Earnings Wages Self-Employment Income

NOT Earnings Pension Income Investment Income Capital Gains

19Retirement Earnings Limitations Test (2 of 2)

Before normal retirement age and collecting Social Security: $1 reduction for every $2 of earnings above

$14,640 for 2012 if don’t reach full retirement age in 2012

$1 reduction for every $2 of earnings above $38,880 for 2012 if do reach full retirement age in 2012

Don’t take Social Security early if plan to continue to work

After attaining normal retirement age, $0 reduction.

20Taxation of Social Security Benefits (1 of 3)

Retirees with substantial income in addition to Social Security benefits. Up to 85% of the Social Security benefits may be

taxable Modified AGI (MAGI)

AGI + Nontaxable Interest + Foreign Earned Income

MFJ Single1st Hurdle $32,000 $25,0002nd Hurdle $44,000 $34,000

21Taxation of Social Security Benefits (2 of 3)

Second Hurdle > MAGI + ½ of Social Security Benefits > First Hurdle, the taxable amount of the Social Security Retirement benefits is the lesser of: 50% of Social Security Benefits, or 50% [MAGI + 0.50 (Social Security

Benefits) less Hurdle 1 Value]

22Taxation of Social Security Benefits (3 of 3)

MAGI + ½ of Social Security Benefits > Second Hurdle, the taxable amount of the Social Security benefits is the lesser of: 85% of Social Security Benefits, or 85% [MAGI + 0.5(Social Security Benefits) less Hurdle

2], plus the lesser of: $6,000 for MFJ, or $4,500 for all other taxpayers,

or The taxable amount calculated based on the 50%

formula and only considering Hurdle 1

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Disability Benefits Benefits payable to workers with:

Severe physical or mental impairments which prevents them from performing “substantial work.”

Cannot perform any gainful work. Payable at any age. Fully insured with 20 quarters of

coverage in the last 40 quarters.

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Family Benefits

Benefit payable to family members of worker receiving retirement benefits or disability benefits. Spouse

62 and older Caring for a child under age 16 Caring for a child who was disabled before age

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Under 18 Under age 19 and in high school Age 18 or older and disabled before age 22

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Survivors Benefits Benefits payable to family members of deceased

individuals who were entitled to benefits. Widow or Widower

60 and older Over 50 and disabled Caring for a child under age 16 Caring for a child who was disabled before age 22

Unmarried Child Under 18 Under age 19 and in high school Age 18 or older and disabled before age 22

Dependent parents of the deceased worker

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Death Benefit One-time $255 death benefit

payment Paid to deceased worker’s surviving

spouse, or minor child (if no spouse).

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Maximum Family Benefit Limit on the amount of monthly Social

Security benefits paid to the family of a deceased worker. Based on the deceased worker’s PIA.

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Medicare Benefits Federal health plan for:

People 65 and older Disabled individuals Individuals with permanent kidney failure

Consists of: Hospital Insurance - Medicare Part A Medical Insurance - Medicare Part B Prescription Drug – Medicare Part D

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Medicare

30 Hospital Insurance – Medicare Part A Covers

Hospital Coverage, and Skilled Nursing Care

Deductible for inpatient hospital care: $1,156 deductible per illness for 2012

for the first 60 days $289 for 2012 per day for days 61-90, and $578 for 2012 per day for days in excess of 90.

Skilled nursing care deductible $145 for 2012 per day for 21st day to 100th day.

Coinsurance based on benefit period

31Medical Insurance – Medicare Part B Individuals pay monthly premium.

Increases based on AGI $100/mo if AGI < $170,000; $320/mo if AGI > $428,000

Covers 80% of: Doctor’s Services Ambulance Transportation Diagnostic Tests Outpatient Therapy Services Outpatient Hospital Services Medical Equipment and Supplies

$140 annual deductible in 2012.

32Prescription Drug – Medicare Part D Began January 1, 2006. Insurance coverage for prescription

drugs. Participant must enroll and pay a

monthly premium and a portion of each prescription.

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Supplemental Security Income Monthly payments to individuals with

low income and few assets: 65 and older Disabled Blind

Single: $698 per month for 2012. Married: $1,048 per month for 2012.

34Effect of Marriage or Divorce on Benefits

Worker receiving benefits based on his own earnings Benefits continue regardless

Individual’s receiving benefits based on spouse’s earnings Benefits cease at divorce, unless

Individual is 62 or older and was married longer than 10 years

Widows and Widower benefits Benefits cease at remarriage unless 60 or older