social security cardOn December 8th US Representative Sam Johnson introduced H.R. 6489, the Social Security Reform Act of 2016. This bill, if made into law, will have a significant impact on Social Security benefits.

In November I did a three part series on Social Security, specifically maximizing your benefit. During that series I noted that the trust fund would run out of money by 2034, or sooner. If nothing is done to right the ship then only about 3/4 of benefits could be paid since by law Social Security cannot spend what it does not have. Its been well known that a combination of reduced benefits and increased revenue would be required to maintain solvency. This Bill claims to modernize Social Security for the 21st century, so I thought we should review the changes this could bring about.

You may here a lot of negative reporting about this like “Sam Johnson Want To Cut Your Social Security Benefits By A Third”, “After Darkness Fell, Republicans Unveiled Their Sinister Plan To Dismantle Social Security”, “Top House Republican Unveils Plan To Gut Social Security”, or “GOP introduces plan to massively cut Social Security”. All of these “stories” are politically motivated and have a fanatical interpretation of the Bill. Bottom line is something has to give, cut benefits, raise taxes, or both. The worst thing to do is to do nothing. All of the following details come from the Bill itself and the evaluation of Social Security’s Office of the Chief Actuary.

I will go through all the proposed changes, some only briefly. I’m not crazy about some of these because they will personally reduce my family’s benefit and raise our taxes, but something has to change, and soon.

Modernize The Benefit Formula

The PIA (primary insurance amount) is a tiered calculation. For example PIA formula for 2017 is:

  • 90 percent of the first $885 of the AIME (average indexed monthly earnings)
  • plus 32 percent of the AIME over $885 and through $5,336
  • plus 15 percent of the AIME over $5,336

In my three part series we defined these terms. The PIA is your Social Security benefit at FRA, Full Retirement Age. The PIA is calculated using your AIME, Average Indexed Monthly Earnings. Your AIME is an average of your highest monthly earnings during the 35 years in which you earned the most. Each of those years is first indexed to account for inflation.

By the formula you can see that it is extremely progressive, significantly penalizing the higher wage earner, while favoring those of lower income, 90 percent of you PIA is based upon the initial $885 per month or $10,620 in annual income.

The proposed bill not only reduces benefits as a whole it also redistributes wealth even further. The new calculation adds an additional bend point. I’m not going to work through the calculation but here it is for those of you who want to work the math:

The three new bend points are at 25 percent, 100 percent, and 125 percent of one-twelfth the AWI from two years prior to initial eligibility. The new PIA factors are 95 percent, 27.5 percent, 5 percent, and 2 percent.

Whats important is the effect. The new formula would result in a slightly higher benefit for those below 90% of the AWI, Average Wage Index. For 2015 this was $48,098.63. As a result 51% of the beneficiaries would have a higher PIA and 49% a lower PIA. Overall the PIA formula change would reduce the annual deficit by .85 percent of taxable payroll. This change would be phased in over 10 years from 2023 to 2032 to those becoming newly eligible.

Raise The Full Retirement Age

For those born in 1960 and later their FRA is 67. The Bill would raise the FRA  to 69 and would be phased in over 7 years beginning with those who turn age 62 in 2023.  A the same time the maximum age at which delayed credits can be earned would increase from age 70 to age 72. This would reduce the annual deficit by .84 percent of taxable payroll.

Use An Accurate Cost Of Living Measure

Don’t you love how they make this sound like a good thing? the Bill proposes using the Chained Consumer Price Index (C-CPI-U) versus the current Unchained (CPI-U). Without going into a lot of boring details the net effect is a reduced Cost of Living Increase (COLA). The current CPI-U already understates inflation especially for retirees as their expenses are weighted heavily towards rent, insurance and healthcare expenses.

In addition the Bill proposes that those beneficiaries whose MAGI is above $85,000 ($170,000 if filed jointly) for the prior tax year, would receive no COLA.

This change reduces the annual deficit by 1.25 percent of taxable payroll and by 2090, 2.31 percent.

Cap On Nonworking Spouse Benefit

For spouses and children of retired workers and disabled workers becoming newly eligible in 2023  a limit would be placed on their auxiliary benefit, an amount based on one-half of the PIA of a hypothetical worker with earnings equal to the national average wage index (AWI) each year up to his or her eligibility year, and who has the same eligibility year as the worker. For retired workers, the PIA is calculated as of age 62 and is increased by COLAs thereafter. For disabled workers, the PIA is calculated as of the year of benefit eligibility and is increased by COLAs thereafter. This provision would reduce the deficit by 0.07 percent of taxable payroll and would be phased over 10 years.

New “Mini-PIA” Formula

Once again without getting into detail this would change the PIA formula. This provision would reduce the deficit by 0.34 percent of taxable payroll by reducing the PIA for some individuals.

Replace The WEP Calculation

The Windfall Elimination Provision calculation would be reworked. WEP affects those who worked for an employer who doesn’t withhold Social Security taxes from your salary, such as a government agency. Any pension you get from that work can reduce your Social Security benefits. This would reduce the deficit by 0.03 percent of taxable payroll.

Require Full Time School Enrollment.

This provision would require full time school enrollment for children age 15 up to age 18 in order to be eligible for benefits. Eligibility for disabled adult child benefits after attaining age 18 would be unchanged. This would reduce the deficit by 0.01 percent of taxable payroll.

Provide A New Minimum Benefit For Workers

This is an involved calculation that raises of the floor for benefits depending upon years of work. This would increase the deficit by 0.23 percent of taxable payroll.

Eliminate The Retirement Earnings Test

Social Security withholds benefits if your earnings exceed a certain level, called a retirement earnings test exempt amount. For the year 2016, the limit on earned income is $15,720 ($1,310 per month). The amount goes up each year. If you are collecting Social Security retirement benefits before full retirement age, your benefits are reduced by $1 for every $2 you earn over the limit. Usually you will get these “lost” benefits back beginning when you reach FRA. Currently those at or above FRA are exempt from the test. This provision would completely eliminate the retirement earnings test for all beneficiaries. This would reduce the deficit by 0.01 percent of taxable payroll.

Provide An Option To Split The DRC

Those attaining age 62 in 2023 or later have the option to split the current law 8 percent DRC into two parts, a credit and a lump sum. The credit equals 6 percent for each year (0.5 percent for each month) that eligible benefits are not taken within three years after reaching NRA. The lump sum is equal to the present value at the time of selecting the option of the additional future monthly benefits the worker is foregoing by taking the 6 percent rather than the full 8 percent DRC. Widows are held harmless from the lump sum decision, meaning that the full 8 percent will apply for widow benefits, even when the deceased worker had elected to take the lump sum option. This basically has no change on the deficit.

Eliminate Federal Income Taxation Of Benefits

Under current law, single tax filers with combined “income” (approximately equal to adjusted gross income plus non-taxable interest income and one-half of their Social Security benefit) greater than $25,000 may have to pay income tax on up to 50 percent of the benefits. If combined “income” exceeds $34,000, up to 85 percent of the benefits may be taxable. The income tax revenue for taxing up to 50 percent of Social Security benefits goes to the OASI and DI Trust Funds. The additional income tax revenue derived from taxing benefits in excess of 50 percent, up to 85 percent, goes to the Hospital Insurance (HI) Trust Fund. All threshold levels are fixed amounts and not indexed to price inflation or average wage increase. Under this provision, the $25,000/$32,000 thresholds would increase from 2045 to 2053, and taxation of OASDI benefits that is credited to the OASI and DI Trust Funds would be completely eliminated starting in 2054. This would increase the deficit by 0.4 percent of taxable payroll.

Provide An Addition To The Monthly Benefit

Beginning in January 2023, augment the monthly benefit amount (not the PIA) for those of qualifying age and eligibility duration with an MAGI below $25,000 if single and below $50,000 if married. The method to arrive at the additional benefit is complicated, of course, so suffice it to say the basic additional amount is calculated as 5 percent of the PIA of for a hypothetical worker with earnings equal to the AWI each year. This would increase the deficit by 0.07 percent of taxable payroll.

Waive The Two-Year Duration Of Divorce Requirement

Beginning in January 2023, for new and current beneficiaries, waive the two-year duration of divorce requirement for divorced spouse benefit eligibility in cases where the worker (former spouse) remarries someone other than the claimant before the two-year period has elapsed. This has negligible affect.

Two other changes include; beginning in January 2023, for new and current disabled widow(er) beneficiaries, change the requirement that disability must occur no later than 7 years after the worker’s death, or after surviving spouse with child-in-care benefits were last payable, to no later than 10 years, and beginning in January 2023, for new and current disabled surviving spouse beneficiaries, eliminate the requirement to be age 50 or older for receipt of benefits.

The net affect of these changes is the actuarial balance for the OASDI program over the 75-year projection period is improved by 2.67 percent of taxable payroll, from an actuarial deficit of 2.66 percent of payroll under current law to a positive actuarial balance of 0.02 percent of taxable payroll under the proposal. Bottom line is that if enacted this would make the Trust Fund Solvent.

This may have been painful to go through, but that’s what the Federal Government is most competent at. A complicated benefit program only gets more complicated. It’s doubtful this would be enacted as is but I would suspect most would be in some form or another. This si something to keep an eye on as it will most likely affect all of our US listeners.

Until next time God bless.