Millions of retirees count on Social Security benefits as one of their key income sources. Unfortunately, both current and future retirees are inevitably going to see the value of their checks fall in 2021 -- and that's true regardless of who is in control of the government.
Wondering how this could happen? The sad fact is, there are rules in place already that will lead to the buying power of benefits declining next year.
1. Full retirement age is going up for many
Full retirement age (FRA) is the age when you can receive your standard Social Security benefit. While it used to be 65, revisions to the law in 1983 changed it to between 66 and 67. Those changes were gradually phased in.
For Americans born between 1943 and 1954, full retirement age was set at 66. That means the last retirees with a FRA of 66 reached that age in 2020. Starting next year, any future retirees will need to wait a little longer before they hit FRA and become eligible for their standard benefit. Specifically, anyone turning 66 in 2021 will need to wait until they're 66 and 2 months old.
FRA moving to a later age means either missing out on months of benefits if you wait until the later FRA to claim them or accepting a smaller benefit by claiming early. And it's not just people born in 1955 who are losing out due to the change. Anyone who hasn't hit their full retirement age by 2020 will face an effective reduction in their benefits next year.
The change to FRA starting in 2021 also means future retirees have less chance to earn delayed retirement credits, which become available for each month you wait to claim up until age 70. If your FRA is 66 and 2 months instead of 66, you've lost out on the chance to earn delayed retirement credits for those extra two months.
2. The small COLA isn't keeping pace with inflation
Unfortunately, COLAs are supposed to help ensure benefits keep pace with inflation, and they aren't doing that. Benefits have been losing buying power for decades because the measure used to calculate them isn't a very good one. And next year's COLA will be the smallest since 2017, with some experts suggesting the government's measurement of inflation was especially inaccurate this year due to changing consumer habits caused by COVID-19.
Whenever seniors get a raise that's not large enough to keep pace with rising costs, this reduces the real value of their benefits. While their checks may get a little bit bigger on paper, they actually buy fewer goods and services. This will likely happen in 2021, so retirees could be left with less.
3. The threshold at which benefits are taxed isn't indexed to inflation
Speaking of inflation, when tax brackets aren't indexed to inflation, this results in an effective tax increase every year. This simple fact explains the third reason the value of benefits will fall in 2021 and each year thereafter.
The 1983 law that changed full retirement age also imposed taxes on some Social Security benefits. These taxes weren't supposed to apply to all retired workers. Retirees would be subject to them only if their "provisional" income exceeded $25,000 for single filers or $32,000 for joint filers. Provisional income was defined to include half of Social Security benefits plus modified adjusted gross income.
Obviously, due to inflation and wage growth, many more people each year have provisional incomes above these thresholds than in the 1980s. They'll all be subject to taxes even though having a provisional income of $25,000 or $32,000 doesn't provide nearly the same buying power as it did back then.
Taxing benefits that have a lower inflation-adjusted value than in the past also erodes the value of those benefits. And since year-over-year wage growth means an increasing number of people every year will exceed the thresholds at which benefits are taxed or will see a higher amount of their benefits taxed, millions of retirees will experience a resulting decline in buying power in 2021.
While higher taxes on benefits, benefits losing buying power due to inflation, and the change to full retirement age won't have a huge immediate impact on the dollar amount of Social Security checks in 2021, these small changes can add up to thousands of dollars in reduced benefits over the course of retirement. And that's bad news with so many older Americans reliant on Social Security to help them make ends meet.
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