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If you receive Social Security, don’t count on a raise next year

by Joseph Arroyo | Contributor
September 30, 2020

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Low interest rate and inflation environments are attractive to borrowers. They can also help retiree’s lower their debt payments. Low inflation has a downside for people on fixed incomes, though. Cost of living adjustments (COLA) are small or non-existent in a low inflation environment. This can be a problem for those retirees who aren’t protected from rising Medicare premiums.

What is the current interest rate and inflation outlook?

In May of 2020, interest rates hit historic lows. Rates set directly by the Federal Reserve (like the Federal Funds Rate) and those tied to the bond market (10-year Treasury bonds) are as low as they’ve been in living memory.

These low interest rates are a boon for anyone trying to lower their debt payments. You can take advantage of these low interest rates to refinance higher-interest loans like:

  • Residential mortgages
  • Auto or boat loans
  • Commercial mortgages

In addition to these, you might choose to pay off higher or floating-rate interest debt using a home equity line of credit (HELOC). Good candidates for paying off with a HELOC include:

  • Credit cards
  • Lines of credit
  • Second mortgages

This is the good side of our current low rates. Interest payments can be lowered in order to free up income.

As far as inflation goes, the official numbers, measured by the CPI and other Federal Reserve metrics, show very low inflation. This is also a boon. Costs are generally rising slowly. Although this is less true for food and health care, costs for many high-ticket goods like electronics, cars, and oil-dependent services are flat or falling.

The real downside to low inflation is the expected effect on cost of living adjustments. Cost of living adjustments may be added to certain pension plan payments. But, they’re mostly applied to government or union retirement payments. Social Security, for instance, adjusts benefit payments based on official inflation measures.

This low inflation has led to a 1.3% COLA for Social Security for 2021. This is a problem because the Medicare Part B premium will increase $3.90 per month.

This will bring the standard Part B premium to $148.50 per month. Since Part B premiums are deducted from Social Security payments, people are faced with the possibility of a drop in take-home payments.

Table showing Full Retirement Age of Social Security

How does the hold harmless provision protect people?

Fortunately, there is a provision that protects people from just such a situation. The so-called “hold harmless” provision prevents Medicare premium increases from lowering the Social Security payments for many people.

In any year, Medicare premium increases are limited for those on Social Security. This provision doesn’t apply to three groups of people, though:

  • People new to Medicare (new beneficiaries),
  • People who are not receiving Social Security, and
  • People who pay higher Medicare premiums due to high earnings
  • Part B premiums begin to increase with individual adjusted gross income (AGI) of $87,001 or joint AGI of $174,001.

    What is the impact of taking Social Security before full retirement age?

    This problem of a flat cost of living increase combined with rising Medicare premiums is worse for high wage earners who are drawing Social Security before their full retirement age (FRA). For 2020, if you make more than $18,240, your Social Security may be reduced. In this case, you actually experience three negatives:

  • Low COLA
  • Higher Part B premium
  • Reduced Social Security payments due to high wage earnings
  • This reduction for high earnings changes based on how many years before FRA you receive Social Security:

    • All years before your FRA - $1 reduction for every $2 earned over the limit ($18,240)
    • The year of your FRA - $1 reduction for every $3 earned over the limit ($48,600)

    In practice, if you take Social Security at age 62 when your FRA is 66, you’ll face a reduction of $1 for every $2 you earn over the limit until the year you turn 66. In the year you turn 66, but before your birth month, you’re payment will be reduced $1 for every $3 you earn in excess of the income threshold.

    If you haven’t carefully planned for these circumstances, you could be facing a significantly reduced Social Security payment compared to what you were expecting. This is doubly tricky since the wage limits can affect spousal Social Security payments, too.

    Strategies for maximizing Social Security income while still earning money

    There are a few things you can do to mitigate this situation. First, if at all possible, don’t take Social Security until you attain FRA. For many people, this is age 66 and 6 months. For others, it’s 67. In either case, once you attain your FRA, there is no earnings limit. You can receive any amount of wages and still receive your full Social Security benefit.

    Another strategy might be to simply reduce the amount you work, if you’re an employee. Dropping to part time or perhaps negotiating for richer benefits and less W2 wages could get your income below the earnings threshold.

    More advanced strategies would be to structure your income differently. The Social Security benefit reduction only applies to wages, so passive income doesn’t count. This means income from sources like:

    • Interest
    • Dividends
    • Annuity payments
    • Pension income
    • Loans against life insurance policies
    • Capital gains from the sale of real estate

    These sources can be used for living expenses, but they won’t be counted toward the Social Security income limit. To any extent possible, use these income streams to pay your living expenses if you take Social Security before full retirement age and will otherwise earn more than the income limit.

    Income planning in the context of your retirement plan

    Some of these income steams can generate a big tax bite, so always consult with your retirement and tax professionals before receiving any distributions of cash. Also, be sure you discuss your desire to take Social Security early with your advisors so that all the tax ramifications can be incorporated into your retirement and estate plan. As you near retirement age, be sure you’re on the same page as your advisor regarding the timing of Social Security, as well as your desire to keep working.

    Alliance America can help

    Alliance America is an insurance and financial services company. Our financial planners and retirement income certified professionals can assist you in maximizing your retirement resources and help you to achieve your future goals. We have access to an array of products and services, all focused on helping you enjoy the retirement lifestyle you want and deserve. You can request a no-cost, no-obligation consultation by calling (833) 219-6884 today.

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