"Unintended consequences". You have probably heard this term used from time to time when governmental policy, designed to provide a positive outcome, sometimes also creatives an unintended negative outcome. Well, such may be the case for some Medicare Part B enrollees in 2016 if no further governmental action is taken.
A little known and rarely used social security payment rule and it's connection to Medicare Part B premium increases has created quite an inequity in the application of Medicare Part B premium increases scheduled for 2016. Incredibly, Part B Medicare premiums are scheduled to increase by a whopping 52% for an estimated 25% of Medicare Part B recipients while the remaining 75% of recipients will see no increase in their premiums due to a "Hold Harmless" provision included in the social security rules and regulations.
The Social Security Administration recently announced that there would be no cost of living adjustment (COLA) for social security payments in 2016. This was bad news for retirees on social security struggling to keep pace with rising costs, especially as it relates to health care expenses. This is only the third time in the past 40 years that social security had a zero percent increase in COLA.
The COLA provision in social security benefits was designed, among other reasons, to offset any increases in Medicare Part B premiums. If you are receiving social security your Medicare premiums are deducted directly from your social security check. However, if there was a zero COLA for social security and Medicare premiums increased, your "net" social security check would be reduced. In this instance, in order to protect social security beneficiaries from receiving reduced benefits, the so called "Hold Harmless" provision was enacted. This provision ensured that one's social security "net benefit" would not be reduced if there was a Medicare Part B premium increase coupled with no increase in social security COLA.
However, the Hold Harmless Provision ended up protecting only 75% of Medicare enrollees. The remaining 25% of "unprotected" enrollees were not only unprotected but also had to bear the full brunt of these premium increases for ALL Medicare enrollees!
The three basic categories of "unprotected" enrollees subject to 2016 Medicare Part B premium increases include high income earners (about 5% of Medicare enrollees), "dual eligibles" (those on both Medicaid and Medicare) and finally those who, for one reason or another, were receiving 2015 benefits from only Medicare Part B or social security, or from neither program.
For these three groups, Medicare Part B premiums will increase from $104.90 to $159.30 per month. The exception is for the high income group whose premiums will spike to over $500 per month. The "dual eligibles" will essentially not be affected because their premium increases will be passed on to their state Medicaid agencies (who, by the way, are already under significant financial pressure).
Clearly, it is not fair or logical that the 25% of "unprotected enrollees " should bear the burden of the full cost of Medicare Part B premium increases applicable to all Medicare enrollees. The White House and some members of congress are already looking into possible remedies for these "unintended consequences" of the "Hold Harmless" provision in the social security rules. We can only hope that this issue is resolved before the 2016 Medicare premium spikes take place.
One of the most important and valuable benefits built into our robust social security program is the feature providing for cost of living adjustments. This feature was added to the social security system in 1975 as a way to protect retirees from the ravages of inflation which can eat away at one's purchasing power. This is no small benefit and can be especially critical for lower income retirees who struggle to make ends meet as it is.
Unfortunately, for only the third time in the past 40 years, there will be no cost-of-living adjustment for social security benefits in 2016. The other two times this happened were in 2010 and 2011, also as a result of the protracted low inflation environment we've experienced over the past 7 years. Given that over 65 million Americans receive benefits from social security, this zero cost-of-living adjustment will have a significant impact on approximately 20% of the U.S. population.
The Social Security Act provides for an automatic increase in social security benefits "if" there is an increase in inflation as measured by the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). Since there was no increase in that index over the past 12 months ending September 2015, there will be no cost of living adjustment to social security benefits for 2016. Although the cost of living adjustments from 2012-2015 were a modest 3.6%, 1.7%, 1.5% and 1.7% respectively, these adjustments remain a valuable benefit in helping retirees to keep up with overall price increases encountered in day to day living.
So what was the primary factor resulting in a zero cost-of-living adjustment? As you may have guessed it was declining energy prices. The steep reduction in energy costs had a significant effect in driving the overall inflation rate to zero. But therein lies the more important issue at hand. Is the government using the appropriate CPI index as it pertains to measuring cost-of-living for retirees?
Many groups advocating for retirees have long complained that CPI-W is not the appropriate indicator for cost-of-living affecting retirees. People who work have different spending patterns than retirees. For example, when compared to retirees, people who work spend more time driving (therefore spend more on gasoline) and also spend less on health care and long-term care than retirees. There is no question that cost of living increases for health care and related expenses has increased at a much greater rate, and affect retirees more, than the costs related to energy prices.
Given that medical care costs are rising faster than other goods, advocates for retirees favor using what's called the CPI-E (E for elderly), which attempts to take into account the different spending patterns for retirees. To that end, Rep. Eliot Engel (D-N.Y.) has introduced a bill that would amend the current law by requiring the use of the CPI-E instead of the current CPI-W when calculating COLA for people on social security.
This is clearly an important issue affecting a large and growing sector of our population. Seniors are already suffering as a result of a protracted low-interest rate environment which has held interest rates on CD's and other safe and liquid investment options at historical lows and, as a result, have reduced there income in retirement.
Millions of our seniors, especially our lower income seniors, are suffering as they struggle to make ends meet. It is unacceptable, I believe, to have a mechanism within the social security system which systematically disregards the cost of living factors which are specifically applicable to our senior population. Let's credit Congress who in 1975 added a mechanism (cost-of-living adjustments) to the social security system to help protect our seniors from rising prices in retirement. Now it's time to refine that mechanism so that we can once again help to take care of our seniors in a more effective and meaningful way.
It's not uncommon for a politician to change their position on one or a number of issues. In fact, it's not even uncommon for them to change party affiliations! But when you are Donald Trump and you say pretty much anything, people tend to listen and often expect to hear some outlandish statement delivered in an equally outrageous manner. He's a ratings machine for sure. However, when Trump discusses Social Security he has proven to be generally more informed than most of his Republican competitors.
To be clear, I am not a supporter of Mr. Trump. I find offensive his statements about John McCain not being a war hero and many of his other disparaging comments that we have all heard by now. Nevertheless, sometimes buried in all his rhetoric are some interesting commentary worth pondering.
Recently, Mr. Trump changed his position on extending the Full Retirement Age for social security benefits. When Scott Pelly of 60 Minutes asked Mr. Trump if he still wanted to delay the full retirement age to 70, he said "No. I don't think we should do that anymore. I want to take back money that we are sending to other countries that want to kill us, and without increases, and we are not going to raise the social security age".
If you are interested in looking up which countries we send foreign aid to and how much we send you can go to "foreignassistance.gov". There is no question that the US sends billions of dollars each year to countries we have significant issues with. I am not going to address this particular matter in this blog however but what interested me most was Mr. Trump's decision to no longer support extending the full retirement age to age 70. He now wishes to keep things as they are.
So what's his motivation behind this significant change in policy affecting social security? His new thinking probably lies in his past position on social security. On March 15, 2013, while addressing the Conservative Political Action Committee in Washington, Mr. Trump stated "As Republicans, if you think you are going to change very substantially for the worse Medicare, Medicaid, and Social Security in any substantial way, and at the same time you think you are going to win elections, it just really is not going to happen".
Mr. Trump went on to say at the same gathering, "Social Security faces a problem: 77 million baby boomers are set to retire. Now I know there are some Republicans who would be just fine with letting these programs wither and die on the vine. The way they see it, Social Security and Medicare are wasteful "entitlement programs". But people who think this way need to rethink their position. It's not unreasonable for people who paid into the system for decades to expect to get their money's worth- that's not an "entitlement", that's honoring a deal".
And there you have it. Mr. Trump apparently understands one fundamental element of social security, and that is that social security is a very important issue for millions of Americans preparing for retirement and it is not realistic to expect to win an election if you propose to make drastic changes to the program.
There is no question that changes need to be made to Social Security in order to protect it's long term viability for all future beneficiaries. Whether Mr. Trumps latest plan to infuse Social Security with cash by cancelling foreign aid to anti-American countries would be sufficient or appropriate is yet to be determined. It's certainly an issue that will create a lot of debate and interest, a fact I'm sure that did not escape The Donald!
In the complex field of social security retirement income maximization planning, a general rule of thumb is that you can increase your benefits by delaying the start of those benefits. From age 62 to 70, your benefit amount will increase by approximately 8% per year. In addition, any cost of living adjustments (COLA) applicable during that period will also increase your benefit amount.
In spite of these facts, approximately 40% of retirees elect to take their benefits at age 62 and nearly 70% take their benefits prior to full retirement age (which is 66 for current retirees). The reasons for filing early vary from the need to take money as early as possible, poor health, or the inability to continue to work.
In addition, the conventional thinking regarding retirement plan (eg. IRA's and 401K's) distributions is that one should delay withdrawals as long as possible in order to preserve and grow your retirement nest egg. As such, by filing for social security benefits early one could postpone withdrawals on retirement plans, at least until age 70 1/2 when required minimum distributions would commence.
However, this may not be the the optimal "draw down" strategy from a tax minimization perspective, as well as for many other reasons. In fact, in most cases, social security should probably be treated as the most prized retirement dollars that people should try to enhance. Unlike other retirement assets, social security offers a combination of inflation-fighting COLA, longevity protection, investment risk elimination, spousal and divorced spousal benefits, survivor benefits and children's benefits.
From a tax minimization perspective, it may also be more beneficial to draw down on retirement assets first, allowing for increases in social security benefits. This strategy may appear to be counter-intuitive but, in many cases, social security payments may qualify for much lower effective income tax rates than income provided by liquidating traditional retirement accounts.
Although traditional retirement accounts allow for tax-deferred investment growth, all distributions are treated as ordinary income and taxed at the recipient's highest marginal tax rate. Social security payments, by contrast, enjoy substantial exemptions from Federal income taxes.
To calculate the amount of your social security payments subject to tax, you must calculate your "Provisional Income". The latter is the sum of your Adjusted Gross Income (AGI) + one-half of your social security benefits + tax-exempt income. If this combined income is less than $32,000 for a couple ($25,000 if single) then your social security payments are totally free of Federal income tax. Starting at these levels, 50% of social security benefits will be taxable, rising to a high of 85% for incomes above $34,000 (single) and $44,000 (joint filers). However, no more than 85% of social security benefits are subject to tax no matter how high your income is.
As such, albeit in an extreme example, if the only income a couple had was from social security then that couple would pay no income taxes on their combined social security income of up to $64,000! Although this is a highly unlikely scenario, it does demonstrate the advantageous tax treatment of social security benefits. Even the wealthiest tax payers should take note of the fact that the maximum amount of social security benefits that they are required to include in income is 85% versus 100% for ordinary income investments.
Since taxable retirement account income increases a person's AGI, and thus may boost their tax rate on social security benefits, by spending down IRA balances early in order to defer taking social security, people are not only trading a dollar of high-tax retirement income for a dollar of lower-taxed social security, they are also reducing their future tax bite on social security benefits in the process.
Therefore, the conventional wisdom of taking income from your tax-deferred savings accounts as late as possible may not always be the best nor the most tax-efficient retirement income strategy when examined in combination with social security benefits. Since the latter offers significant tax benefits for most tax filers, the optimal retirement income strategy should take this into account.
Ash Ahluwalia, NSSA, CCSCA, MBA