Lifetime payroll tax contributions will exceed the amount of Social Security benefits many of today's workers will receive in retirement — despite the fact that today's retirees tend to live longer than previous generations. The higher a worker's income, the lower the return on his payroll taxes, according to a recent article in the winter 2015 issue of the Journal of Retirement.
While some may argue this new research is proof that Social Security is a bad deal for high earners, I think it gives financial advisers one more reason to encourage clients to optimize their claiming strategies. After all, they have paid a lot of money in taxes over their careers. They should make sure they maximize their benefits through creative strategies such as file and suspend or filing a restricted claim for spousal benefits where appropriate.
Sylvester Schieber, author of the article “Social Security costs in the larger context of retirement savings,” agrees.
“I think there is a pervasive sense that Social Security is a super deal that links back to an earlier era that is now past,” said Mr. Schieber, a former member of the Social Security Advisory Board and an independent benefits consultant retired from Towers Watson. “I suspect that many folks would be dumbfounded if they realized that the net cost of participating in Social Security for an average worker today is roughly five years of their lifetime earnings.”
Mandatory participation in the Social Security system grows more expensive for higher earners as the maximum amount of wages subject to payroll taxes increases almost every year. For 2015, the first $118,500 of earnings is subject to the 12.4% payroll tax that is evenly split between employers and employees to fund Social Security retirement, disability and survivor benefits. That's a 1.7% increase from the maximum $117,000 taxable wage in place in 2014. Mr. Schieber's research did not include the impact of additional payroll taxes used to fund Medicare.
While a very low earner who was born in 1949 and retired in 2014 at age 65 is expected to receive $28,336 more in lifetime benefits than the cumulative value of taxes paid on his earnings, a high-earning male is expected to be a net loser to the tune of nearly $196,500, according to Mr. Schieber's calculations.
For a single male of the same age who was a medium earner over this career — defined as average annual earnings of $40,784 — the net loss of $85,110 from participating in Social Security would be the equivalent of 2.1 years of his average indexed lifetime earnings used to determine his benefits. A single-earner couple is the only one in the medium-earner category to come out ahead, expecting lifetime benefits in excess of the value of taxes equal to $151,131, or 3.7 years of average earnings due to the value of spousal and survivor benefits for a non-working spouse.
For maximum earners — defined as $98,750 in average annual earnings — the net lifetime loss is $378,171 for a single male; $340,354 for the longer-lived single female and a whopping $665,582 for a married couple where both spouses are maximum earners. Only the single-earner married couple breaks even in this category.
“One way that folks with a reasonable life expectancy can at least ameliorate the deadweight loss is to pursue claiming strategies that will maximize their expected lifetime benefits,” Mr. Schieber told me in an email. “Higher earners are in a better position to take advantage of the benefits of late claiming than most folks because they often have alternative income sources they can tap while delaying Social Security claiming.”
Despite the wisdom of waiting to claim a larger benefit, the majority of retirees still claim Social Security benefits as soon as they are eligible at age 62.
For 62-year-olds who claim Social Security in 2015, their monthly benefits will be 25% lower than they would be if they waited until their full retirement age of 66. The reduction will grow to 30% as the full retirement age increases to 67 by 2022.
A separate article in the Journal of Retirement, “Why retirees claim Social Security at 62 and how it affects their retirement income,” found that those who delay claiming until their full retirement age tend to have greater income and wealth in retirement and rely less on Social Security than those who claim earlier.
“Even when comparing early and delayed claimers with similar total income after claiming, average household income for delayed claimers was higher at age 72 than for early claimers,” wrote authors Mark Glickman and Sharon Hermes, both senior economists with the U.S. Government Accountability Office.
“Increasing life expectancy and time spent in retirement raise the potential costs to retirees claiming early,” they wrote.
Although the percentage of Americans claiming Social Security at 62 has declined considerably in recent years from 43% to 32% for men and from 49% to 38% for women, 62 remains the most prevalent age to claim Social Security benefits.
While some financial advisers may focus on the value of delaying Social Security until age 70 when benefits are worth the maximum amount, the real challenge is to nudge clients to delay claiming from 62 to 66. That way, more retirees would benefit from larger monthly income, no restrictions on their earnings while receiving benefits and the possibility of exercising some creative claiming strategies.
(Questions about Social Security? Find the answers in my ebook.)