Social Security
December 21, 2016 | by Chris Stein, CFP®, Finance Instructor at Colorado State University
Social Security Reform Act of 2016

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This December (2016), representative Johnson from Texas has proposed a bill entitled the “Social Security Reform Act of 2016” that includes a number of changes to Social Security that the actuarial office at the Social Security Administration estimates will extend the solvency of Social Security for at least 75 years.  The media sensationalists are already yelling from the tree tops about the cut in benefits proposed in this bill.  My goal today is to describe the key provisions of this bill to educate people on what is actually in the bill.

Status Quo Leading to Disaster

Before I get into details, let me say that the status quo is leading to a disaster for Social Security as it is currently structured.  And the formula is really simple.  Social Security takes in money from workers and then pays it out to retirees and disabled people.  The money going out has to be completely supplied by people paying in.  When the equation is out of balance one of two things has to happen.  Either more goes in or less comes out in benefits, or some combination of the two.  It is probably not realistic to expect a solution where this is solved on just one side, so the best we should expect is a balanced solution that includes some cuts to benefits and some increase in contributions by workers. I am not claiming this bill has the perfect mix of the two, but all the media headlines focusing on just the benefit cuts are being sensational and disingenuous about the bill.  Now on to the major details:

New benefit Formula

Phase in a new benefit formula: Creates a new formula for people turning 62 in 2023 or later that will skew benefits a bit more toward low wage workers.  The phase in will take place over a 10 year period so will not be in full effect until 2032.  This will affect people as old as 46 today, but only those 36 and under will be fully under new formula. This overall would reduce benefits, mostly to higher wage workers.

Change WEP

Change the Windfall Elimination Provision (WEP): While WEP is not repealed completely, this act would alter how it is applied to create more of a graduated effect rather than the all or nothing cliff style offset most people experience now. This one is revenue/benefit neutral.

Increase Retirement Age

Increase Normal Retirement Age to 69: Just as the last “fix” to the system raised the NRA from 66 to 67, this act proposes to increase it from 67 to 69.  It would increase in 3 month increments beginning with those turning 62 in 2023 until fully implemented for those turning 62 in 2030.  This one is an obvious benefit reduction since to get your full PIA you must be 2 years older.

COLA

Remove Cost of Living Adjustments for some and change for others: Removal of COLA for those with MAGI above certain thresholds (those with significant other sources of income).  Change others to “Chained CPI” inflation measure that will reduce the COLA each year, but arguably represent “actual” inflation better.  This one is a benefit cut.

Limit Auxiliary Benefits

Limit Auxiliary Benefits for Spouses and Children: Right now spouses and children of those collecting SS retirement benefits qualify for benefits up to 50% of the retiree’s PIA (full retirement age benefit) with certain family maximum limits.  The proposal would limit these benefits to the max of 50% of the worker’s benefit OR 50% of the AVERAGE worker’s benefit.  This is a cut to benefits for higher wage workers since these benefits would be capped at the average.

Require children to attend school: If a child of school age is collecting an auxiliary benefit from a retired parent, they are required to attend school to receive the benefit.  Revenue/benefit neutral.

Remove Earnings Test

Remove Earnings Test: Right now if you claim retirement benefits before reaching your full retirement age you are subject to the Earnings Test.  This can reduce your SS benefits if you make over a certain amount working.  Upon reaching FRA this test goes away.  This provision would eliminate the earnings test completely.  This one is essentially revenue/benefit neutral, but gives people more flexibility in claiming/working.

Taxation of SS Benefits

Stop taxation of SS benefits: Proposal would eliminate taxation of SS, phased in from 2045 to 2053.  Right now up to 85% of your benefits can be subject to tax, but this provision would remove that, however not fully until 2053.  In 2045 they would start raising the thresholds on income (MAGI) that trigger the taxation until in 2053 the taxation is removed.  This is ultimately a benefit increase.

Partial Lump Sum Options

Allow partial lump sum options for Delayed Retirement Credits: Put this one in the “adding flexibility” category.  In 2015 the changes to SS removed the ability to opt for a lump sum payout of suspended benefits.  This provision would grant to people between FRA and 70 the ability to take some of their delayed retirement credits as a lump sum rather than simply a higher monthly benefit.  Revenue/benefit neutral.

Divorced Spouse Benefits

Waive the 2-year rule for receiving Divorced Spouse benefits: Currently someone who is divorced, but had been married at least 10 years is able to claim a spousal benefit from their ex-spouse’s record only if the ex-spouse has filed for benefits OR they have been divorced at least 2 years.  This provision would remove the 2-year requirement IF the ex-spouse has remarried.  Adds flexibility but is essentially benefit/revenue neutral.

Impacts on Participants

There are a few other provisions in this proposal, but the above represent the items most widely impactful for Social Security participants.  As you can see, most of these are revenue/benefit neutral.

The items that prolong the solvency of SS are almost entirely benefit cuts, but the vast majority are targeted at higher wage workers who likely have other retirement resources.  A couple provisions actually INCREASE benefits for low wage workers.

I would personally like to see a little more contribution to the solution coming from revenue-increasing changes (higher payments into the system), but many of these provisions seem reasonable.  The one exception in my opinion is the change to COLA.  This type of change has a cumulative and significant effect over time, in this case effectively reducing benefits for everyone over time.  One of the most insidious long term risks to seniors is inflation.  The current inflation measure does not keep up with the actual cost of living a retiree experiences.  The change proposed makes this worse.  I think spreading that risk to everyone through slightly higher SS withholding is a fairer way of balancing the books.

This proposal is a long way from becoming law.  Stay tuned for updates…

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