Social Security sets inflation adjustments

With the New Year comes new rules, and after two years with no inflation adjustments for Social Security, changes are afoot for 2012. Most notably, those who receive Social Security and Supplemental Security Income benefits will see their monthly checks increase by 3.6 percent.

Though this is good news for those on the receiving end, these inflation adjustments also have an impact on those who are still contributing a portion of their wages through Social Security taxes and those who choose to begin receiving benefits early. The changes may not be drastic, but it’s important to consider them as you’re looking at your 2012 financial picture whether you’re still in the workforce, retired or planning to retire.

Higher

earnings limit

Every wage earner is subject to the Social Security (FICA) tax up to a maximum earnings amount. The tax does not apply after that earnings limit is reached. In 2011, the rate was 4.2 percent and the earnings limit was $106,800, but is being raised to 6.2 percent and $110,100 for 2012. A similar tax applies to self-employed individuals.

The maximum contribution to Social Security can rise significantly in 2012 as a result of the increased earnings limit and tax rate, and this adjustment will produce extra tax revenues. The maximum employee contribution to Social Security under the reduced earning limit and the 2011 rate was only $4,486 in 2011, but will increase to $6,826 in 2012 for those at the top levels.

Currently, there are proposals in congress to extend the reduced, 4.2 percent rate for the employee portion of the Social Security tax for 2012, but it is unclear whether the extension will happen.1

Note that all earned income is subject to the 1.45 percent Medicare tax (the employee portion is also matched by 1.45 percent employer portion). No earnings limit applies for this tax. Beginning in 2013, this rate will increase by 0.9 percent for an employee whose wages are over a threshold of $200,000 (or $250,000 for those who are married and filing jointly).

Earnings limitation

for early retirees

Full retirement age as defined by Social Security currently stands at 66 years old for those born between 1943 and 1954, but retirement benefits can be collected as early as age 62. Under the new adjustments, if you start accepting Social Security prior to your full retirement age and are still working and earning income, you could lose some of the benefits, but those who work while collecting benefits after reaching full retirement age will not have reduced benefits.

If a person under full retirement age is receiving Social Security and has an income that reaches $14,640 in 2012, his or her Social Security benefits could be reduced by $1 for every $2 of earned income above that limit. If 2012 is the year you will reach full retirement age at 66, you can earn as much as $38,880 (the limit is lower for those who reached full retirement age in 2011) before sacrificing Social Security benefits. In that case, $1 will be deducted from benefits for every $3 of income you earn above the limit. In the month you reach full retirement age, the earnings limit no longer applies. From that point forward, there is no reduction of Social Security benefits regardless of your earnings.

Though the technical aspects may feel overwhelming, it’s a good idea to know where you and your family fall as these changes take effect in 2012, especially if your income is at or near the maximum earnings subject to social security tax, if you’re planning for retirement or if you’re about to begin collecting your Social Security benefits.

Remember that planning ahead is the best way to mitigate the effects of these and any other changes that may affect your financial situation in 2012.

Ronald Garver, CFP® is a certified financial planner practitioner), CRPC® (chartered retirement planning counselor.