Social Security Benefits

by Glenn J. Downing, MBA, CFP®

The Social Security program is officially called OASDI – Old Age, Survivor, and Disability Insurance.  As the name suggests, it consists of two parts – the disability income part, and the retirement income part.

The program is funded by payroll taxes under the Federal Insurance Contributions Act (FICA):  7.65% of your gross pay, matched by your employer, up to $118,500 in 2016.  This means that, on that same amount, your employer withholds $9065.25 from your pay, and matches that amount equally.  Technically, the social security amount is 6.2% and the Medicare amount is 1.45%, and these total to 7.65%.  If you earn more than $118,500, then only the 1.45% Medicare tax is withheld on the amount of your pay north of $118,500 – so you sort of get a little raise in your paycheck.  (Under Obamacare, when you earn above $200,000 the Medicare rate rises to 2.35%.)

By law, any excess of revenue that Social Security receives must be loaned to the General Fund of the Treasury.  There is no lockbox, per se.  Estimates vary widely, but sometime in the 2030’s Social security is projected to have no further surpluses, but will instead need to borrow funds from the Treasury.  This is the underfunding that we read about not infrequently in the news.  I’ll give a few thoughts on that later in this piece.

As with any Federal program, the rules surrounding OASDI are detailed and complex.  My intention here is to provide a good, broad overview.

In order to be covered, one must have 6 quarters of creditable coverage for disability income, and 40 quarters of coverage for retirement income.  The definition of disability is very strict under social security:  you must not be able to perform any gainful work.  There is a 5-month waiting period before benefits are paid (retroactively to filing date), and the disability must have lasted for 12 months or be expected to do so.  After 24 months on social security disability one also qualifies for Medicare benefits, even if well short of age 65.

The retirement benefit is based on the worker’s Primary Insurance Amount (PIA – sort of funny, isn’t it?  I know another use for PIA).  This is a calculation of how much of your earnings will go toward calculating your benefit.  There are three important years to remember:  age 62, NRA (Normal Retirement Age), and age 70.  Your full, or normal benefit, is paid at your NRA.  Years ago NRA was age 65.  But, due to financial instability, Congress began phasing in a two-year rise in NRA.  Retirees today have an NRA of somewhere between 65 and 67, and younger workers today all have an NRA of 67.  If you chose to defer your retirement benefits until age 70, your benefit will increase by 8% per year over your NRA benefit.  So three years of delay can increase a $2000/month benefit to $2519.42/month.

Should you defer your benefit until age 70?  Depends upon the facts of the situation.  If there is not longevity in your family, and you’ve perhaps had some health issues, I’d say consider getting it while you can enjoy it.  On the other hand, if your parents are in their 90’s and still sharp and enjoying life, I’d say consider delaying.  Basically Social Security reserves a pool of money for you.  If they pay out a larger amount over a shorter period of time – statistically they are paying out the same amount of dollars.  But if you live past the life expectancy tables, that is a good deal for you.

How about early retirement before NRA?  There is a reduced benefit available at age 62.  The reduction in benefit can be calculated without too much difficulty as long as the worker’s PIA is known.  Multiply the PIA by the number of months before age 65 divided by 180.  For example, if my PIA is $2000, and I want to retire at age 64 – 12 months before my NRA, then my calculation is $2000 * 12/180, or $133.33.  My monthly benefit is not the $2000 I’d earn at age 65, but $1866.67.

There’s another hugely important consideration involved in drawing Social Security before NRA, and that is loss of benefits.  Once you’ve hit NRA you can draw your full benefit and also earn all you’re able with no penalty.  But before NRA there are two rules:  the first is that the government will deduct $1 from your benefit check for each $2 you earn above $15,720.  In other words, if your benefit is $1000/month, and you earn $39,720, the government will withhold 100% of your social security check.  In this example you’ve earned $24,000 above the threshold, meaning they hold back ½ of that amount, or your entire benefit of $1000/month.  The second rule applies if you draw benefits in the same year that you attain NRA.  In that case the government withholds $1 for every $3 that you earn above $41,880.  It is very important to consider carefully the wisdom of early election of social security.  Retirement can easily last 30 years or even longer, and the reduced benefit that may just work out now will come up far short in later years.

A separate issue is that the benefit will be ultimately be taxable under the provisional income formula – and I’ve written a separate piece about that.

So who can claim retirement benefits?  The insured retiree, of course.  The retiree’s spouse is entitled to a benefit if overage 62, has a child in care who is under age 16, or has a disabled child in care of any age.

The surviving spouse of a deceased worker can collect that worker’s benefit at age 60.  A divorced spouse, i.e. former spouse, of an insured worker can collect benefits on that worker’s PIA if over age 62, the marriage lasted at least 10 years, the divorce was more than two years ago, and the former spouse has remained single.

Generally the spouse will choose between his/her own social security payment or that of the spouse, whichever is higher.

There are also benefits for a surviving spouse who is caring for dependent children.  And yes – there is a death benefit.  $255.00.  You read right.  For some reason Congress has never indexed this amount.

I’ll end this piece with a few thoughts about the solvency of the program.  A common question I’m asked in a financial planning engagement is this:  Glenn, should I plan on receiving Social Security?  Will it even be there for me?  I’ll say yes – plan on it.  Social Security is the third rail of politics, and it is my belief that it will always be there in some form or another.  (For those of you who’ve never lived in a city with a subway, the third rail is an electrified rail that runs along the tracks.  There is a foot from the railcar that rides along the third rail, thus powering the car with electricity.  Pretty much instant electrocution if you touch it.)

Throughout its history Congress has bought itself votes by increasing the benefit, but they haven’t always raised revenue, i.e. taxes, in a commensurate fashion.  There is certainly a history of raised payroll tax rates, and as I’ve noted above, the NRA has been raised.  What’s being talked about now? A few things:

  • Raising NRA again.  65 really is the new 55.  People are living lots longer.  Some would phase in another rise to age 70.
  • Raise payroll taxes again.  Not likely to get a Congressman re-elected.
  • Add a means test.  This changes the program dramatically from social insurance to a welfare benefit.  A formula will determine whether I qualify for any benefit, even though I’ve paid into the system all my working life.  Social Security becomes another redistribution effort, in that Congress takes from those who’ve earned too much and gives it to those at the lower end of the scale.
  • Privatize it.  There is precedent for this – Chile has privatized its social insurance, and with considerable success.  People have a choice of investment accounts, which include government bonds, into which they can allocate their funds.  This puts the onus on providing for retirement squarely on the taxpayer.

Wherever the program ends up is anyone’s guess.  But is it a very valuable benefit in retirement.  Consider this:  if I retire at age 67 with a benefit of $2000/month, and expect to live to age 90, at 6% the present value of this stream of income is nearly $300,000.  This means that at age 67, if I invested a lump sum of $300,000 at 6%, and drew it down by $2000/month, the money would last to my age 90.  What if I live till 95?  Then the present value becomes $325,000.  Any way you look at it, this is a valuable benefit.

Let’s do one more calculation, though.  Say I came out of college at age 22 and earned a steady $60,000 for the rest of my working life, to age 67.  That’s 45 years.   I would have deferred $3720 each year, which my employer would have matched.  What if instead I had invested both my half and my employer’s half in my own brokerage account, and earned a steady 6% rate of return?  I would have accumulated a little more than $1.5 million.  Now re-read the previous paragraph.  There’s a lot to be said for taking a close look at Chile’s example.

I hope we’ve provided good information for you here.  If you have any questions, by all means get in touch:  Visit our website at, where you’ll see all of our blog entries and be able to book an appointment to come see us.

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