Social Security: It's all about the income replacement rates

Here’s a common misunderstanding about how Social Security benefits work that I hear about often from readers: my benefit amount is determined by the amount I have paid into the system.

It sounds sensible enough. If you’re covered by Social Security - and most Americans are - you pay into the system via the Federal Insurance Contributions Act (FICA) - 12.4% of your wages, evenly split between workers and employers. But FICA is the premium you pay in order to be insured under the system. Your benefit amount is determined by your wage history, and for a very good reason: Social Security is designed to replace a certain amount of preretirement income. Generally, the program replaces about 40% of income, although the figure is higher for low-income earners, and lower for higher-income people.

One of the themes of my forthcoming book - Retirement Reboot: Commonsense Financial Strategies for Getting Back on Track - is that Social Security replacement rates are too low. As a general rule of thumb, retirees need to replace about 70% to 80% of preretirement income in order to maintain their standard of living. The median amount saved by workers age 55-64 in a workplace retirement plan is $70,000, according to Vanguard - a figure that suggests a very large number of Americans will be retiring on Social Security alone.

Replacement rates already are falling as a result of the Social Security reforms of 1983. That overhaul gradually raised the full retirement age (FRA) from 65 to 67 - effectively raising the bar for receiving a full benefit. For anyone born in 1960 or beyond, the FRA is 67.

If a worker born in 1960 claims at the earliest eligible age (62), she would receive 70% of her full benefit, compared with 80% if the FRA had remained at age 65. The higher FRA is equivalent to an across- the-board benefit cut of roughly 13 percent. Taxation of benefits—also enacted in 1983—contributes to the lower replacement rates, too. A third factor is the rising cost of health care - Medicare Part B premiums typically are deducted from Social Security benefits.

The Center for Retirement Research at Boston College has calculated how replacement rates will change over time for an average earner who retires at ave 65. It concludes that this worker could have expected a 36% replacement rate is she claimed in 2015 (after Medicare Part B premiums and income taxes), but only 29% is she claims in 2035.

I hope younger workers are paying attention to plans now floating around in Congress to further increase the FRA to 70. This appears to be a centerpiece of Republican plans for an overhaul of Social Security, and it would be exactly the wrong move - because it would further reduce replacement rates over time.

Report details deceptive Medicare Advantage marketing tactics

An investigation of deceptive marketing practices by Medicare Advantage plans released this week details ways that plans have misled customers to spur enrollment. Released by Democrats serving on the Senate Finance Committee, the report comes on the heels of a major investigation published last month by The New York Times of exploitive practices by Advantage plans. And, coming in the middle of the annual Medicare enrollment period, the report serves as an important caution to beneficiaries and their families.

The Senate committee solicited feedback from states on deceptive marketing practices, and catalogs the responses. It includes instances of plan marketers posing as representatives of the Internal Revenue Service and other government agencies, preying on vulnerable people with dementia and cognitive impairment and other scams:

“Six states reported concerns about false or misleading marketing materials. For example, in response to the Committee’s inquiry, Director Michael Wisehart from the Arizona Department of Economic Security (DES) wrote that, “The onslaught of mail appearing to be official correspondence from Medicare or Centers for Medicare and Medicaid Services, was noted as misleading and prevalent. This type of correspondence can divert the beneficiary’s attention and cause confusion about plan providers.”17 One example provided by the Georgia Department of Human Services shows an insurance agent that uses “MedicareAdvantage.com” as its website. Another example provided by the Ohio Department of Insurance (ODI) shows a company that used a bus with Medicare in its name and website.

“MedicareBus.com,” they are automatically redirected to another website for an independent insurance agency.

Here’s an example, submitted to the Senate committee by the Ohio Department of Insurance:

None of this new, but the interesting question is this: why has the Centers for Medicare and Medicaid (CMS), which runs Medicare, not cracked down harder on these deceptive practices?

The New York Times covers the new Senate report here.

What I’m reading

The 4% rule just became a whole lot easier . . . For disabled workers, a tight labor market opens new doors . . . . Among seniors, a declining interest in boosters . . . Inflation adjustments mean lower tax bills for some . . . These doctors admit they don’t want patients with disabilities . . . Health insurance inflation is poised to drop . . . Why you need a post-retirement LinkedIn profile . . . Is the uptick in elder poverty a sign of things to come?