Author Topic: How does low taxable income affect future Social Security Benefits?  (Read 7384 times)

GrOW

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As we continue to reduce our taxable income via available retirements accounts options, HSA account, etc., one question that my wife and I have not been able to easily answer is - What affect does this have on our future Social Security benefit?

Since we wont be extreme REs - we got into this mindset in out late 30s so we are targeting age 50-52 as our FI age - we will have contributed into Social Security for about 30 years. Quite a few of those years resulted in high taxable incomes - in the range that would give us max Social Security payouts one day. Now our taxable income should continue to fall going forward even in the face of raises given my first statement above. I doubt that we will get down to the very very low taxable others here have shared but we can try like heck to get close.

So how will all of this affect our SS benefits in our 60s?

terran

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Re: How does low taxable income affect future Social Security Benefits?
« Reply #1 on: November 20, 2015, 07:36:40 PM »
As luck would have it one of the early retirement bloggers recently wrote a well thought out post on this very topic: http://rootofgood.com/early-retirement-social-security/

Edit: typo
« Last Edit: November 20, 2015, 08:35:41 PM by terran »

GrOW

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Re: How does low taxable income affect future Social Security Benefits?
« Reply #2 on: November 20, 2015, 07:40:40 PM »
As long would have it one of the early retirement bloggers recently wrote a well thought out post on this very topic: http://rootofgood.com/early-retirement-social-security/

First, thank you for the reply and help.

Second, holy wall of text that is a long article. It will give me something to read this weekend for sure.

Third, that is a bit creepy how recent that article was written. Maybe it is just a topic others have asked about but still... creepy. In a good way since it answers our question though.

Rural

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Re: How does low taxable income affect future Social Security Benefits?
« Reply #3 on: November 20, 2015, 11:00:52 PM »
 I just read the rootofgood article, and it is indeed fabulous. It doesn't address your original question about taxable income, though. I think the answer to that question is that the HSA contributions are going to reduce your Social Security income, but not the retirement contributions. The HSA contributions are exempt from FICA, but the rest aren't.


 Now, when you have time to read the rootofgood article, you'll see why that slight reduction doesn't matter much at all.

unno2002

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Re: How does low taxable income affect future Social Security Benefits?
« Reply #4 on: November 21, 2015, 07:45:19 AM »
To manually calculate potential social security payout, get the form at:

http://www.socialsecurity.gov/pubs/10070.pdf

Paul der Krake

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Re: How does low taxable income affect future Social Security Benefits?
« Reply #5 on: November 21, 2015, 08:05:47 AM »
I just read the rootofgood article, and it is indeed fabulous. It doesn't address your original question about taxable income, though. I think the answer to that question is that the HSA contributions are going to reduce your Social Security income, but not the retirement contributions. The HSA contributions are exempt from FICA, but the rest aren't.


 Now, when you have time to read the rootofgood article, you'll see why that slight reduction doesn't matter much at all.
That was also my understanding, but it would be nice to have confirmation. Unfortunately, I do not yet have a year of income with HSA contributions listed on my personal SSA.gov account. Maybe someone who does could tell us whether it shows or not?

seattlecyclone

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Re: How does low taxable income affect future Social Security Benefits?
« Reply #6 on: November 21, 2015, 09:08:30 AM »
Anything that reduces your social security tax withholding will also reduce your social security benefits. 401(k) contributions and IRA contributions do not reduce this tax. HSA contributions through your paycheck generally will.

Rural

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Re: How does low taxable income affect future Social Security Benefits?
« Reply #7 on: November 21, 2015, 10:44:53 AM »
I just read the rootofgood article, and it is indeed fabulous. It doesn't address your original question about taxable income, though. I think the answer to that question is that the HSA contributions are going to reduce your Social Security income, but not the retirement contributions. The HSA contributions are exempt from FICA, but the rest aren't.


 Now, when you have time to read the rootofgood article, you'll see why that slight reduction doesn't matter much at all.
That was also my understanding, but it would be nice to have confirmation. Unfortunately, I do not yet have a year of income with HSA contributions listed on my personal SSA.gov account. Maybe someone who does could tell us whether it shows or not?


I should, with three years in an HSA. Now, if I can just remember my SS login...

Cathy

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Re: How does low taxable income affect future Social Security Benefits?
« Reply #8 on: November 21, 2015, 11:30:06 AM »
The FICA tax applies to "wages ... received ... with respect to employment" as defined in 26 USC § 3121(a), (b). See 26 USC § 3101(a). Meanwhile, the program commonly referred to as Social Security takes into account "wages" as defined in 42 USC § 409 (which codifies § 209 of the Social Security Act, as amended ("SS Act")). These are separate statutes with independent definitions. The definitions are not the same and it is possible for income to be wages for the purpose of one of the statutes but not the other.

Elective deferrals to a plan commonly referred to as a 401(k) plan are unambiguously subject to FICA tax, with the usual maximums and exceptions. 26 USC § 3121(v)(1)(A).

However, the separate question of whether elective deferrals to a 401(k) plan (hereinafter, "elective deferrals") count as "wages" for Social Security purposes (hereinafter, "SS wages") is more interesting. As of December 18, 1989, the status of things was that:
  • SS Act § 209(d) excluded elective deferrals from SS wages, but
  • an undesignated paragraph near the end of SS Act § 209 stated that "Nothing in any of the foregoing provisions of this section (other than subsection (a) of this section) shall exclude" elective deferrals from SS wages.

Under this old state of affairs, elective deferrals were clearly included in SS wages because the undesignated paragraph prevented SS Act § 209(d) from having any effect to exclude elective deferrals from SS wages.

On December 19, 1989, Congress decided to make some changes to this statute. The Omnibus Budget Reconciliation Act of 1989, PL 101-239 ("OBRA89"), § 10208(d), 103 Stat 2106, 2479-81 renamed SS Act § 209(d) to SS Act § 209(a)(4) and also gave the previously mentioned undesignated paragraph an actual designation (namely, SS Act § 209(i)). However, Congress declined to change the text that read "other than subsection (a) of this section" in the previously undesignated paragraph. Since the exclusion of elective deferrals from SS wages was now found in subsection (a), the previously undesignated paragraph (now subsection (i)) was now ineffective to prevent elective deferrals from being excluded from wages.

Therefore, as of December 19, 1989, a plain reading of the statute leads to the conclusion that elective deferrals to a 401(k) plan are excluded from SS wages. However, the Social Security Administration apparently takes the position that this effect of the OBRA89 was accidental and should be disregarded as a "scrivener's error". The Administration doesn't actually explicitly state this position in any public document, but it's the only explanation for the assertion in their policy manual that elective deferrals are included in SS wages. RS 02505.240(B)(7). This position is fairly defensible because the heading of OBRA89 § 10208(d) reads "Clerical Amendments", which suggests that the changes were not supposed to cause a substantive change in the law.

This post does not discuss any plans other than plans commonly referred to as 401(k) plans.
« Last Edit: November 21, 2015, 12:40:47 PM by Cathy »

Rural

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Re: How does low taxable income affect future Social Security Benefits?
« Reply #9 on: November 21, 2015, 12:27:11 PM »
Checked my account and earning history at mySocialSecurity. SS is definitely counting earnings I deferred into a 403(b) and into a 457 over the last couple of years, and is definitely not counting the earnings that went into my HSA through employer deferral. It is countin a lump sum I put into the HSA after taxes last summer, presumably because I lost the FICA advantage doing it that way.

RootofGood

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Re: How does low taxable income affect future Social Security Benefits?
« Reply #10 on: November 21, 2015, 03:46:32 PM »
Checked my account and earning history at mySocialSecurity. SS is definitely counting earnings I deferred into a 403(b) and into a 457 over the last couple of years, and is definitely not counting the earnings that went into my HSA through employer deferral. It is countin a lump sum I put into the HSA after taxes last summer, presumably because I lost the FICA advantage doing it that way.

+1, can confirm. Also, hey guys, glad you liked that article.  :)

As long as your HSA is coming out pre-tax from your employer, you should be skipping SS taxes on the HSA contributions and it won't count toward SS earnings.

mxt0133

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Re: How does low taxable income affect future Social Security Benefits?
« Reply #11 on: November 21, 2015, 04:52:17 PM »
To partially address the OPs original question of how low taxable income affects SS benefits, there is no doubt that it will lower your overall benefits, however it is not a fixed ratio.  Meaning that lowering your income will not lower your future benefits on fixed dollar for dollar basis. 

In the book 'Guide to Social Security 2014' which I just happen to have in front of me there is a table called 'Social Security Replacement Rations for Retirement at FRA (Full retirement age)':

Estimated Annual Salary              Replacement Ratio   (Estimated Benefits)* (SS contribution @12.4%)
$20,000                                      56%                       ($11,200)                 ($2,480)
$45,000                                      42%                       ($18,900)                 ($5,580)
$72,000                                      35%                       ($25,200)                 ($8,928)
$117,000                                    28%                       ($32,760)                 ($14,508)

()* Entries not in table, for illustrative purposes

So basically you get more benefits as a percentage of your income at the lower end of the salary ranges.  As you creep up in income the replacement ratio drops, even though you are contributing more.  So it is yet another win for being FIRE and getting you income below a certain level that will maximize your replacement ratio.

Looking at the columns in (), your benefits to not go up proportionally as your SS contributions.  At the income level of $117,00 for example you are paying 5.85 times more SS taxes than at $20,000 income level.  However, your benefits are only 2.95 times higher at the $117k level than at the $20k level.

Drifterrider

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Re: How does low taxable income affect future Social Security Benefits?
« Reply #12 on: December 28, 2015, 10:47:16 AM »
Something to remember about OASDI (Social Security).  It is not a retirement fund but a pooled insurance fund.  People who make less (and pay less) get a larger percentage but their monthly benefit is still smaller.   I'm in the top range and wouldn't go back to the bottom range.  Also, your disability benefit is larger if you earn more, smaller if you earn less.   

MustacheAndaHalf

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Re: How does low taxable income affect future Social Security Benefits?
« Reply #13 on: January 13, 2016, 12:54:10 AM »
As luck would have it one of the early retirement bloggers recently wrote a well thought out post on this very topic: http://rootofgood.com/early-retirement-social-security/

There's a flaw in the "rootofgood.com" article that is especially relevant to MMM.  It states:
"Ignoring inflation, a person earning $70,000 per year for 10 years will have the exact same AIME as the person earning $20,000 per year for 35 years."
Unfortunately false, and critically relevant to this thread.  Social Security has a "Windfall Elimination Provision" (WEP) that specifically targets this situation:
https://www.ssa.gov/planners/retire/wep-chart.html

For that exact situation ($700,000 earned in 10 years or 35 years), you can visit ssa.gov's calculator and you wind up with:
10 recent years at $70,000/year gives you $1041/mo benefits
35 recent years at $20,000/year gives you $1415/mo benefits

You can verify the numbers yourself at ssa.gov.  I plugged in $70,000 for years 2005-2014 and then $20,000 for years 1980-2014 to arrive at the above numbers.
https://www.ssa.gov/planners/retire/AnypiaApplet.html
« Last Edit: January 13, 2016, 01:30:51 AM by MustacheAndaHalf »

RootofGood

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Re: How does low taxable income affect future Social Security Benefits?
« Reply #14 on: January 13, 2016, 10:49:04 AM »
There's a flaw in the "rootofgood.com" article that is especially relevant to MMM.  It states:
"Ignoring inflation, a person earning $70,000 per year for 10 years will have the exact same AIME as the person earning $20,000 per year for 35 years."
Unfortunately false, and critically relevant to this thread.  Social Security has a "Windfall Elimination Provision" (WEP) that specifically targets this situation:
https://www.ssa.gov/planners/retire/wep-chart.html

The WEP only applies in very limited situations.  From https://www.ssa.gov/pubs/EN-05-10045.pdf : "This provision may affect you when you earn a pension from an employer who didn’t withhold Social Security taxes".

In other words, the WEP applies to some government (and possibly other) employees who didn't have SS withheld from their paycheck because they paid into a pension plan at their employer.  In that case, you may have your benefit reduced from the WEP. 

The vast majority of MMM readers aren't in that situation (everyone's an engineer or programmer right?). 

Another Reader

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Re: How does low taxable income affect future Social Security Benefits?
« Reply #15 on: January 13, 2016, 11:28:44 AM »
They are only equivalent, as noted, if you exclude inflation.

Your highest 35 years of earnings subject to FICA are each indexed up by the National Wage Index to get to their current value.  That's where inflation comes in.  That indexed pot of money is divided by (35 x 12) to get your Average Indexed Monthly Earnings.

In my case, I came out way ahead on this calculation because it gave numbers for my early years of employment that are well above what those exact jobs pay today.  I encourage everyone with enough time in the system to have a substantial history to do the year by year calculation to understand how the calculation works.

MustacheAndaHalf

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Re: How does low taxable income affect future Social Security Benefits?
« Reply #16 on: January 13, 2016, 11:57:24 AM »
There's a flaw in the "rootofgood.com" article that is especially relevant to MMM.  It states:
"Ignoring inflation, a person earning $70,000 per year for 10 years will have the exact same AIME as the person earning $20,000 per year for 35 years."
Unfortunately false, and critically relevant to this thread.  Social Security has a "Windfall Elimination Provision" (WEP) that specifically targets this situation:
https://www.ssa.gov/planners/retire/wep-chart.html

The WEP only applies in very limited situations.  From https://www.ssa.gov/pubs/EN-05-10045.pdf : "This provision may affect you when you earn a pension from an employer who didn’t withhold Social Security taxes".

In other words, the WEP applies to some government (and possibly other) employees who didn't have SS withheld from their paycheck because they paid into a pension plan at their employer.  In that case, you may have your benefit reduced from the WEP. 

The vast majority of MMM readers aren't in that situation (everyone's an engineer or programmer right?).
How do you explain the second half of my post? (repeated here)
Quote
You can verify the numbers yourself at ssa.gov.  I plugged in $70,000 for years 2005-2014 and then $20,000 for years 1980-2014 to arrive at the above numbers.
https://www.ssa.gov/planners/retire/AnypiaApplet.html

MustacheAndaHalf

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Re: How does low taxable income affect future Social Security Benefits?
« Reply #17 on: January 13, 2016, 12:02:33 PM »
They are only equivalent, as noted, if you exclude inflation.

Your highest 35 years of earnings subject to FICA are each indexed up by the National Wage Index to get to their current value.  That's where inflation comes in.  That indexed pot of money is divided by (35 x 12) to get your Average Indexed Monthly Earnings.
I plugged in $70,000/year from 1980-1989, and the result was between the above numbers: $1233.

I'm using the social security administration's website to get these numbers, using their defaults.

beltim

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Re: How does low taxable income affect future Social Security Benefits?
« Reply #18 on: January 13, 2016, 12:10:38 PM »
They are only equivalent, as noted, if you exclude inflation.

Your highest 35 years of earnings subject to FICA are each indexed up by the National Wage Index to get to their current value.  That's where inflation comes in.  That indexed pot of money is divided by (35 x 12) to get your Average Indexed Monthly Earnings.
I plugged in $70,000/year from 1980-1989, and the result was between the above numbers: $1233.

I'm using the social security administration's website to get these numbers, using their defaults.

$70 k in 1980-1989 was above the wage cap, by a lot: https://www.ssa.gov/oact/cola/cbb.html

So the benefits you calculated were actually based on salaries of:
1980    25,900
1981    29,700
1982    32,400
1983    35,700
1984    37,800
1985    39,600
1986    $42,000
1987    43,800
1988    45,000
1989    48,000

Another Reader

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Re: How does low taxable income affect future Social Security Benefits?
« Reply #19 on: January 13, 2016, 12:16:46 PM »
You are implicitly including inflation, Justin (ROG) excluded inflation.  The amount you contribute is only part of the calculation.  The indexing for inflation, which varies from year to year, is the other part.

beltim's point is also important.  Only the wages subject to the SS tax count.

Why don't you print out the worksheet, look up the index factors, and see how much the inflation indexing affects your virtual "pot" of money?  In my opinion, it really helps in understanding how your future annuity is calculated.

MustacheAndaHalf

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Re: How does low taxable income affect future Social Security Benefits?
« Reply #20 on: January 13, 2016, 12:27:30 PM »
beltim + Another Reader - Good points, but taken together it's impossible for $70k/year to be the same as $20k/year.  Either the $70k/year comes late and loses out to COLA... or the $70k comes before 1999, and loses out to the wage cap.

I've plugged in 3 examples on the social security website, which I consider a canonical source of information.  I'd highly recommend people wondering how things impact them to do the same, with their specific numbers:
https://www.ssa.gov/planners/retire/AnypiaApplet.html

MDM

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Re: How does low taxable income affect future Social Security Benefits?
« Reply #21 on: January 13, 2016, 12:29:48 PM »
As luck would have it one of the early retirement bloggers recently wrote a well thought out post on this very topic: http://rootofgood.com/early-retirement-social-security/
There's a flaw in the "rootofgood.com" article that is especially relevant to MMM.  It states:
"Ignoring inflation, a person earning $70,000 per year for 10 years will have the exact same AIME as the person earning $20,000 per year for 35 years."
You are implicitly including inflation, Justin (ROG) excluded inflation.  The amount you contribute is only part of the calculation.  The indexing for inflation, which varies from year to year, is the other part.

beltim's point is also important.  Only the wages subject to the SS tax count.

Why don't you print out the worksheet, look up the index factors, and see how much the inflation indexing affects your virtual "pot" of money?  In my opinion, it really helps in understanding how your future annuity is calculated.

Everyone is correct.  Some more correct than others. ;)

If inflation=0 (as RoG stipulated) then $70K over 10 years (assuming $70K is below that year's wage max) gives the same benefit as $20K over 35 years (with the same assumption on wage max).

Inflation has of course not been zero.  When an assumption is not met, the conclusion based on that assumption usually is not met.

If you don't want to recreate the anypia calculations from scratch, you could check the 'SocialSecurity' tab in the case study spreadsheet.  If you have indexed earnings of $70,000 for years 2005-2014, or $20,000 for years 1980-2014, you get a PIA of $1,295 for the default assumptions in that tab.

beltim

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Re: How does low taxable income affect future Social Security Benefits?
« Reply #22 on: January 13, 2016, 12:35:56 PM »
You can obtain to indexing factors here: https://www.ssa.gov/oact/cola/awifactors.html