THE PERPLEXING WORLD OF SOCIAL SECURITY AND EARNINGS IN RETIREMENT

Launched in 1935 during the Great Depression as a principal component of Franklin D. Roosevelt's New Deal recovery program, the Social Security System has earned an unquestionable reputation for the reliability of its stream of monthly checks to retirees. It also represented the nation's first comprehensive source of retirement income.

But did the laws that authorized the payments and ensured their reliability also:

• Ensure the payments — based on your lifetime income — would be large enough to sustain a comfortable retirement for seniors?
• Require Social Security benefits to be taxed too much by the same Treasury Department which issued them?
• Reduce the payments too severely for those who needed money before becoming 65 ?
• Enable beneficiaries to get back all of the money they had paid into the system over the years?

While these questions — and the question of the system's continued viability as the ratio of beneficiaries to taxed active workers increases — are debatable and debated by lawmakers, the most baffling for many individual workers as they plan for the approach of retirement is: when should you start receiving Social Security benefits?

The answer is not easy, thanks in part to changing regulations. Nor is it the same for all individuals.

Yet it is very important. It depends not only on when you start to receive benefits, but also how large your payments will be. The earlier you start, the smaller your payments. It also influences how much you may earn from other work once you start receiving benefits, as well as how much net Social Security income you will have left after income taxes.

To understand how these things are determined, one must first understand the regulatory concept of "normal retirement age" ( also called "full retirement age") at which retirement benefits equal the "primary insurance amount." For those born in 1937 or earlier, it is 65. For those born in 1960 or later, it is 67. For those born in 1938 through 1959, it is in-between. (Useful tables which spell out this and other relevant regulations appear on the Social Security Administration's Web site, www.ssa.gov).

If you decide to begin receiving Social Security before your "normal" retirement age, your benefits will be reduced. If you begin receiving benefits at age 62, your benefits may be reduced as much as 30 percent if you were born after 1959 or 25 percent if you became 62 in 2005. This is a reduction that shrinks your monthly benefits permanently.

If you decide to defer getting Social Security past your "normal" retirement age (delayed retirement credits), your benefits may be increased by percentages depending on when you were born: from 3 percent if you were born in 1917-1924 to 8 percent if you were born in 1943 or later. You would receive your largest benefit by beginning benefits at 70.

Whatever the SSA determines you should get monthly (to be further adjusted annually for inflation, unlike most private sector pensions) may be (further) reduced if you get work for pay before you reach your "normal" retirement age. Your benefits are reduced by $1 for each $2 you earn above an annual limit. Last year, that limit was $12,000; this year, it's $12,480. In the year you will reach "normal" retirement age, the reduction is less — $1 in benefits for each $3 you earn above $33,240 in 2006. The year after you reach normal retirement age there is no longer a penalty applied to benefit amounts received.

For example, a retiree with earned income of $25,000 and a Social Security benefit of $1,000 per month would receive just $478 each month after a reduction due to earnings.

Recall also that some of your Social Security benefits may be subject to income tax. If you are filing a federal income tax return as an individual and have "provisional income" — defined as adjusted gross income plus nontaxable interest (such as interest from tax-exempt bonds and income dividends from municipal bond mutual funds) plus 50 percent of your Social Security benefits — between $25,000 and $34,000, you may have to pay income tax on that 50 percent. If your combined income exceeds $34,000, up to 85 percent of your benefits may be taxable.

If you file a joint return and you and your spouse have provisional income (as defined above) of between $32,000 and $44,000, you may have to pay tax on 50 percent of your Social Security benefits. However, up to 85 percent of your benefits become taxable when your combined income exceeds $44,000. Consider carefully the overall impact of any actual benefit reductions you will face and any potential tax liability when making the decision when to begin receiving your Social Security benefits.

March 2006-- This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Deidra Fulton, a local member of the FPA.

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