As the new year is quickly coming upon us, for those that are receiving social security benefits, it’s worth taking a good look at what changes are going to be in store for the new year.
The good news is, you should be getting a raise due to the Cost Of Living Adjustment (COLA). The 1975-82 COLA’s were effective with Social Security benefits payable for June in each of those years. Thereafter COLA’s have been effective with benefits payable for December.
The first COLA, for June 1975, was based on the increase in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) from the second quarter of 1974 to the first quarter of 1975. The 1976-83 COLAs were based on increases in the CPI-W from the first quarter of the prior year to the corresponding quarter of the current year in which the COLA became effective. After 1983, COLAs have been based on increases in the CPI-W from the third quarter of the prior year to the corresponding quarter of the current year in which the COLA became effective.
The actual formula used to determine your standard benefit – your primary insurance amount – always stays the same. The Social Security Administration adjusts your wages for inflation, figures out your average monthly wage during the 35 years your inflation adjusted wages are highest, and provides you with benefits equaling a percentage of that average, which is your Averaged Indexed Monthly Earnings (AIME).
Specifically, you’ll get benefits equaling:
- 90% of your AIME up to a first “bend point”
- 32% of AIME between the first and second “bend point”
- 15% of your AIME above the second bend point
Bend points are income thresholds. And that’s where the change comes in. The bend points are going up next year as they do in most years. Specifically, the first bend point is going up from $960 in 2020 to $996 in 2021, and the second is going up from $5,785 to $6,002.
Next year’s bend points will apply only to a limited group of retirees. That’s because the bend points used to determine your benefits are those in effect during the year you turn 62. Those who turned 62 in 2020 received 90% of AIME up to $960; 32% of AIME between $960 and $5,785; and 15% of AIME above $5,785. But those who turn 62 in 2021 will receive 90% of AIME up to $996; 32% of AIME between $996 and $6,002; and 15% of AIME above $6,002. Those who turn 62 in 2022 will likely see even higher bend points, and so on each year.
These bend points are important, because they make the Social Security formula progressive. Lower earners get a larger percentage of their average wage replaced than higher earners do. But it’s also important that they go up each year to keep pace with inflation, otherwise lower earners wouldn’t get a large enough percentage of their income. In 1979, for example, the bend points were $180 and $1,085, which means that average benefits would be a whole lot smaller for the vast majority of Americans with an average wage of more than $180 per month.
Of course, while the bend points are going up, there are still many workers who won’t get benefits equaling 90% of all of their career average wages, since there are many people with an average above $996. While it’s important for every American to have supplementary savings to live on in retirement in addition to their Social Security benefit, those with higher average wages see a smaller percentage of their total income replaced. They must take that into account when setting their retirement savings goals.
Sadly, the news isn’t all good. If you’re under full retirement age (FRA) and you’re hoping to work and collect Social Security benefits at the same time, you could run into a problem in the form of the retirement earnings test (RET)
Under the RET, if you work when you’re under full retirement age for the whole year, you’ll temporarily forfeit $1 in Social Security benefits for every $2 earned above $18,240 in 2020 (or above $18,960 in 2021). If you’re under FRA for part of the year when you’re working, you’ll forfeit $1 in Social Security benefits for every $3 earned above $48,600 in 2020 (or $50,520 in 2021). Once you’ve hit FRA, though, you can work as much as you want without worry.
The loss of benefits isn’t necessarily permanent. When you’ve reached your full retirement age, the Social Security Administration will calculate the number of months of missed benefits and credit you back any early filing penalties for those months. Since early filing penalties reduce your standard Social Security benefit amount by 5/9 of 1% per month for each of the first 36 months you claimed Social Security before FRA and an additional 5/12 of 1% for each month prior, getting credited back the penalties will raise your check amount slightly.
And over time, you’ll get back the money you missed out on if you live long enough. Still, the fact that working can lead to the loss of Social Security checks in the short term is a big problem if you were hoping to have both a paycheck and benefits to live on as a retiree.
There’s another issue as well, and it applies to everyone regardless of their age. If you work and your paychecks push your provisional income above $25,000 as a single tax filer or $32,000 as a married tax filer, part of your Social Security benefits will be subject to federal tax when they otherwise wouldn’t be.
Provisional income is adjusted gross income plus nontaxable interest income and 1/2 your Social Security benefits. Once it goes above $25,000 for singles or $32,000 for married filers, you’re taxed on up to 50% of benefits. And once it exceeds $34,000 for single filers or $44,000 for married joint filers, you could be taxed on up to 85% of your Social Security.
When you’re taxed on your benefits, that’s money you don’t get back. Of course, owing a bigger bill to the IRS isn’t reason enough to give up working if you like the job or need the money, nor is the fact that you may end up forfeiting some Social Security money under the RET.
But you do need to know that working could have these effects so you can be prepared for the loss of funds when setting your retirement budget. Otherwise, you may anticipate a higher household income than you end up with and that could get you into financial trouble.