August 12, 2012

∴ Social Security Games, Or, You Won't Believe This

We argue over the size of our Federal debt in America, yet little of the debate is about the largest and most troubled components of it. The largest single component of the debt (not a US government web site, but very useful) is the unfunded IOU for the Federal Insurance Contributions Act (FICA) taxes collected over the past several decades. That tax funds both Social Security and Medicare and yes, we’ve already spent all of the money, by leaving it in the general fund where other programs have eaten it.

Our arguments often center instead on nickels and dimes, relatively speaking. Bridge To Nowhere? It was a wasteful, pork-barrel project, but a drop in the bucket beside unfunded entitlements.

We should be tackling the larger problems first, assuring ourselves a stabile future benefit and heading off unsustainable expenditures.

I got a better feel for the Social Security problem while looking into the specifics of my future Social Security benefit, using the Social Security Administration’s online statement and additional resources from around the Internet. Not only is the Old Age Security and Disability Insurance (OASDI) program, as it’s named, a good deal, it might be too good.

You’re no doubt aware that a US worker, having paid into the program for at least forty credits-worth, can begin drawing a benefit at age 62.

(That requirement used to be forty calendar quarters, but the rules were changed equating a quarter to a specific dollar amount, thereby letting workers accrue the newly coined “credits” as fast as their incomes allowed.)

The monthly benefit amount increases yearly for every year a recipient holds off applying, until it reaches its maximum at age 70.

That sounds straightforward enough. Pay in, retire, get a check. Retire later, get a bigger check. Yet provisions in the FICA tax and OASDI program conspire to weaken its long-term prospects.

The FICA tax ceases for higher-paid workers each year when their income crosses an annually adjusted limit, currently $110,100. Well-paid employees get a modest increase in their take-home pay after their income exceeds this taxable limit. No such limit exists for Medicare taxes (thankfully, or that program might already be insolvent).

If we’re justifiably concerned about the future of Social Security, we should not be exempting any higher income from the FICA tax.

A Social Security beneficiary’s spouse is entitled to the larger of two benefits: his or her own, or up to one-half of the main beneficiary’s. A lower-income employee could become eligible for a substantially higher benefit than he or she is due simply by virtue of marriage. This is true whether or not the main beneficiary is actually receiving a payout himself.

The spousal benefit was created at a time when women were rarely in the workforce, instead working in the home and rearing children. That era has largely passed.

Women now enter the workforce as readily as men, stepping out for childbirth and shortly beyond. Most women (and men) who step out of the workforce step back in when their children enter school, if not before. The cost of living and stagnating wages make it a challenge to do otherwise.

In order to make such a benefit payable to the spouse, a main beneficiary may “file and suspend.” Using this strategy, the main beneficiary files for his or her benefit in order to qualify for a spousal payout, then immediately suspends payment of his or her own check. The spouse begins receiving a check, but the main beneficiary does not and continues to qualify for increasingly higher benefits, up to age 70.

Spousal benefits work both ways. Using a strategy called “restricted application,” a beneficiary may elect to file and receive only his or her spousal benefit. Later, the spouses may switch roles and benefits as age dictates a financially better arrangement.

Total household benefits can easily double simply by taking advantage of the spousal benefit in combination with file-and-suspend and/or restricted application, yet these increased benefits are not connected to any working-years income or FICA tax receipts. Indeed, some sources refer to these as "free spousal" benefits.

The is no such thing as a free lunch. We're all paying for these "free" benefits.

Use the benefit tool at Social Security Choices to see what I mean. There are additional tools for single and divorced or widowed workers, as well. (Social Security Choices is a private business, unaffiliated with the Social Security Administration.)

You could go further and pay the site’s authors for a more comprehensive report, but the freebie is adequate to understand how the Social Security program allows for manipulation and what it could be worth to you.

I was able to plan a 51% increase in our household Social Security income by using a subset of these lawful provisions. Others may be able to do better if the couple is closer in age and/or benefits.

Clearly these provisions will benefit my household, and I plan to take advantage of them. I’m advocating that we eliminate them, however.

By leveraging this bonanza of benefit re-arrangement with modest retirement savings, such as 401(k) and IRA investments, Social Security can become an avenue to significantly greater, and longer-lived wealth. Yet wealth creation is not the business of the Federal government.

The rules should be changed to make the program better-funded, yet less of a potential windfall for recipients.

  • Higher income should not be exempt from the Social Security tax. Workers should pay in at the same rate through the end of each year, as they do for Medicare. Any exemption should come at the bottom of the income curve, or the tax should be graduated to make it progressive.
  • There should be no provision for a spousal benefit. Recipients should receive what they individually earn. Workers who choose a lifestyle that keeps them out of the workforce should not receive a benefit as if they were in it. The taxpayer does not owe anyone an income.
  • Alternatively, allow a main income earner the ability to contribute more FICA tax to cover a spousal benefit for a non-working spouse, much as a working spouse may contribute up to $5000 per year to a non-working spouse's Roth IRA.
  • Higher income workers pay in more tax and should receive higher benefits. Lower income workers pay in less tax and should receive a lower benefit. Spouses with disparate incomes should receive disparate benefits.
  • Beneficiaries should not be able to file-and-suspend or practice restricted application in order to qualify a spouse for benefits or ladder-up income, while continuing to increase their own prospective benefit.
What's more, Social Security's basic eligibility ages must be upwardly adjusted. Better nutrition and health care conspire to increase our expected longevity. As a result of that and significant household debt, Americans are working later in life than ever.
  • The "early" retirement age should be upwardly adjusted to 65. The age of maximal benefit should be revised to 72. The penalty for working while collecting Social Security should expire at age 72 as well, rather than today's age 67.

Have you heard any of this in the debt debate? In the Social Security arguments? Probably not. I wasn’t aware of these lucrative provisions until I came across them by accident.

We will not reduce the US Federal debt until we both recognize the true size of it by including Social Security and Medicare entitlements in the balance and re-aligning both with life expectancies, market realities and common sense.