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The Major Myths of Social Security
Richard L. Kaplan
Throughout the long debate on how to balance the federal budget and control the deficit, the one point of universal agreement has been the political inviolability of Social Security. This program has been dubbed the "third rail" of American politics to indicate that those who dare touch it will, politically speaking, be electrocuted. Yet, it has become increasingly clear that this third rail must be touched if the deficit is to be effectively contained. When and how that will be accomplished may depend on the resiliency of what might be described as the major myths of Social Security and how strongly they are believed by the American people.
Myth No. 1: There Is a Trust Fund. Social Security collects revenues from a payroll tax on current workers and uses those revenues to pay benefits to current beneficiaries. Social Security’s revenues presently exceed the amount needed to pay current-year benefits, and the surplus is applied to other federal expenditures such as defense, domestic programs, and interest on the national debt.
Myth No. 2: Social Security Does Not Increase the Federal Budget Deficit. Presently, Social Security brings in more money from taxes than it pays out in benefits. These net revenues reduce the government’s need for funds from other sources and thereby lower the budget deficit. This situation, however, is expected to reverse itself within the next two decades. When this switchover occurs, Social Security will clearly increase the deficit.
Myth No. 3: Retirees Are Only Recovering Their Own Money. For years Social Security taxes were imposed at lower rates and on a much lower wage base than currently. As a result, the average current retiree has recouped all contributions made, including those made by the person’s employer, after only 41/2 years of benefits. Even after making allowances for interest lost on taxes paid, at some point that retiree will be receiving the equivalent of public welfare.
Myth No. 4: Social Security Will Not Be Around When We Retire. Social Security is a program of the United States government, which cannot go bankrupt, unlike private pension plans.
Myth No. 5: Retirement Benefits Are Proportional to One’s Lifetime Earnings. To be sure, the more one earns while working, the more one will receive in Social Security benefits.
A person’s monthly retirement benefit, or "primary insurance amount" (PIA) in Social Security parlance, is calculated by applying a three-factor formula to a worker’s "average indexed monthly earnings" (AIME)—an inflation adjusted surrogate for average lifetime earnings. But this formula is intentionally bottom-weighted so that lower income workers receive proportionally higher retirement benefits.
Myth No. 6: Social Security Always Favors Two-Income Married Couples. It is frequently said that Social Security favors married couples where each partner is an eligible wage earner ("two-income couples") over married couples with the same aggregate income but where only one partner is an eligible wage earner ("one-income couples").
To illustrate: Assume that Sam is married to Leah, who is not an eligible wage earner, and that Sam’s AIME is $3,000, producing a PIA of $1,151. Contrast this one-income couple with Ken and Andrea, each of whom have $1,500 of AIME, producing $733 of PIA each, for a total of $1,466. Thus, the two-income married couple is ahead of the one-income couple with the same aggregate earnings.
But Social Security adds a spousal benefit whenever a spouse’s own work record is lower, or nonexistent. Thus, Sam would still receive his PIA of $1,151, and Leah would receive one-half of her husband’s retirement benefits, or in this case $576 per month—a total of $1,727.
Myth No. 7: Social Security Favors Long Marriages. Social Security also provides a derivative benefit to the ex-spouse of a retiree, if he or she was married to that worker at least ten years and has not remarried (remarriages after age sixty are ignored). So, if Sam had been married three times before marrying his current spouse, all three of his ex-wives plus Leah would each be entitled to collect one-half of his PIA, and the Social Security system would be paying out $1,728 more per month ($576 X 3) than if Sam had been married only to Leah.
Myth No. 8: One Could Do Better by Investing Directly. First, Social Security taxes are collected from employees automatically and do not depend upon an individual’s financial self-discipline. Second, Social Security is guaranteed to make its payments on time and, unlike private systems, poses no realistic risk of default. Third, Social Security is completely portable from job to job, because virtually every type of employment is covered, including self-employment.
Social Security provides derivative benefits to current and former spouses—while the worker is still living. Social Security also pays benefits to certain children under age nineteen that can amount to half of a retiree’s PIA.
When a retiree dies, the surviving spouse or ex-spouse receives the retired worker’s entire benefit (rather than half). A surviving child’s benefit is increased to 75 percent of the worker’s PIA. Even a worker’s parents may be eligible for Social Security benefits if they received half of their support from the deceased worker.
All Social Security benefits are adjusted annually for inflation by means of a cost-of-living adjustment, known by the acronym COLA. Finally, but significantly, Social Security also provides workers with disability coverage.
Myth No. 9: Working After Retirement Makes Financial Sense. To those who perform compensated work while receiving retirement benefits, Social Security applies a "retirement earnings" test. This test focuses exclusively on income earned from the performance of personal services and ignores passive income from investments.
When this test applies, retirees who receive earnings from work will lose a portion of their Social Security benefits if certain thresholds are exceeded.
After a person reaches age seventy, he or she is no longer subject to the retirement earnings test and can earn as much as desired, but up to that point the application of the test can be disastrous.
Myth No. 10: Social Security Benefits Are Taxed More Heavily Than Other Pension Payments. Until 1983, recipients of Social Security benefits paid no tax at all on those benefits. In that year Congress imposed tax on up to one-half of Social Security benefits if a person had income of more than $25,000 for singles, or $32,000 for married couples filing jointly.
In 1993, Congress imposed a second tier of tax for persons with $34,000 of provisional income for singles and $44,000 for married couples filing jointly. This second tier meant that some recipients owe tax on up to 85 percent of their benefits. At the present time, only one in eight Social Security recipients is subject to this second tier of tax.
This analysis was not intended to prescribe solutions for reform of the Social Security system. Debunking these myths does, however, suggest that current levels of benefits could be reduced, certain requirements for eligibility tightened, and certain taxes on recipients extended without breaking faith with the American people. Social Security is too big
to be ignored, but true progress is possible only if its workings are properly understood.
Richard L. Kaplan is professor of law at the University of Illinois College of Law in Champaign, Illinois. This article is a condensed version of an article that appeared at 3 Elder Law Journal 191–214. Copyright © 1995 The Board of Trustees of the University of Illinois. Reprinted by permission.
This article is an abridged and edited version of one that originally appeared in Experience, Winter 1997 (7:2).