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Ted Sarenski
Ted Sarenski
Social Security and retirement planning
Everything you wanted to know, but were afraid to ask.

May 17, 2012
by Ted Sarenski, CPA/PFS

According to a report by the trustees of the Social Security program issued in 2011, 54 million people received some type of Social Security benefit in 2010, totaling $706 billion. According to the Employee Benefit Research Institute, Social Security represents 40% of the income of all elderly people in the United States. The poverty rate for those aged 65 and older was 35% in 1960 and was 9% in 2010. Without Social Security, the poverty rate for people age 65 and older in 2010 would have been 45%, according to the AARP Public Policy Institute.

Obviously, Social Security has become an integral financial consideration for most Americans. To counsel them effectively, advisers must be aware of what the program can and can’t do.

Should I include social security in my retirement planning?

This is a question that only an individual and his or her adviser can answer for each situation. The continued viability of the Social Security program is a topic that has been and will continue to be discussed by politicians and regulators. While an ideal retirement scenario would not depend on Social Security, based on the statistics, it should not be ignored. We don’t know what the future holds, but Social Security is likely to continue as a source of some retirement income for baby boomers. From a planning perspective, any assumptions made about the impact of Social Security on retirement should be conservative.

Every year the government-appointed Social Security Board of Trustees releases a report on the financial outlook for the Social Security and Medicare Trust Funds. The 2011 Trustees Report was released on May 13, 2011.

In the 2011 Annual Report to Congress, the Trustees announced:

The projected point at which the combined Trust Funds will be exhausted comes in 2036—one year earlier than the estimate in last year's report. At that time, there will be sufficient tax revenue to pay about 77% of benefits. Annual program cost is expected to exceed non-interest income in 2011, as it did in 2010, and remain higher thereafter. However, total income, including interest earnings on trust fund assets, is projected to be sufficient to cover annual cost until 2023.

There is no correct answer on how to include Social Security in planning. Ultimately your clients must each make their own retirement planning decisions based on the level of comfort with the risks.

Is there a limit on what I can earn between age 62 and full retirement age?

If you have earned income during this period you will be subject to an earnings test that may cause your Social Security benefit to be reduced. If this happens, when you reach FRA your Social Security benefit will be recalculated upward to account for those months in which benefits are withheld.

For this purpose, earned income includes any wages from your employer and net earnings from self-employment. Other earnings such as pensions, annuities or investment income do not affect your Social Security benefits.

General earnings test

In 2012, a client who begins collecting Social Security benefits after age 62 and before FRA may have earned income up to $14,640 without experiencing any reduction in benefits. Their Social Security benefit is reduced by $1 for every $2 of earned income beyond $14,640.

Earnings test during the first partial year

Earned income prior to collecting benefits is not counted and the earnings test is applied on a monthly basis ($1,220 per month) for the remainder of the first year.

Earnings test in the year FRA is reached

The earnings limit is increased to $38,880 before a reduction applies and the reduction is $1 of Social Security benefit for every $3 of earned income over the limit. The limit applies only to the months before reaching FRA. Starting with the month [full retirement age] FRA is reached, the client can have unlimited earned income and still receive their full Social Security benefit.

See SSA Publication No. 05-10003  for annual changes in the earnings limit.

 ACTUAL CLIENT CONCERN: I am age 62 1/2 and will retire in a few months and begin receiving Social Security benefits. I have an opportunity to do some independent contracting work for my former employer. My independent contractor income will be about $2,200 a month for the remainder of the year (four months). I have been told that there is a Social Security monthly earnings test that allows maximum monthly earnings of $1,220 ($14,640/12). Will my Social Security benefits be reduced because my monthly post-retirement self-employment income will be greater than $1,220 a month?

Is the yearly maximum broken down to a monthly maximum? And will my earnings before retirement be counted toward the yearly maximum?

ADVISER RESPONSE: I’ll answer your last question first. Under a special rule for the first year of retirement, the regular pre-retirement wages you earned before beginning to collect Social Security benefits would not count in the earnings test. Now let’s turn to the question of self-employment income. Once you begin collecting Social Security, the earnings test is applied on a monthly basis at the rate of $1,220 per month. If your monthly earnings after retirement are $2,200 over four months, that adds up to $8,800.

The monthly earnings maximum for four months adds up to $4,880 ($1,220 x 4). That means that you are a total of $3,920 over the limit. The SSA would withhold one-half of that from your benefit ($1 for every $2 you earn). When you reach FRA, the benefit will be recomputed to remove the actuarial reduction for those four months. For more information on working in retirement, see SSA Publication 05-10069.

How does the cost of living adjustment (COLA) work?

The Social Security Cost of Living Adjustment (COLA) is computed each year based on the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) from the third quarter of the prior year to the third quarter of the current year. This formula has been used since 1982. The COLA is then applied to Social Security benefits beginning in the next calendar year. The chart below shows the annual COLA adjustments for the last 36 years.

(Source: http://socialsecurity.gov/cola/automatic-cola.htm)

This article has been excerpted from The Adviser’s Guide to Social Security: Unlocking the Mystery of Retirement Planning. You can purchase the publication on cpa2biz.com.

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Theodore J. Sarenski, CPA/PFS, CFP, is the president and CEO of Blue Ocean Strategic Capital, LLC in Syracuse, N.Y. He serves as chair of the AICPA Personal Financial Planning Executive Committee’s Elder Planning Task Force and is active in the New York State Society of CPAs as well.