There's arguably no program that bears more importance to the financial well-being of our country's seniors than Social Security. Even though the average retired worker is only bringing home a little over $18,000 a year from Social Security, this works out to more than half of the annual income for 62% of current retirees. It's also enough to pull more than 15 million retired workers out of poverty each year.
Suffice it to say, when adjustments are made to the Social Security program, tens of millions of senior citizens pay close attention. Next year, there's a real possibility that a lot of big changes could be made.
One guaranteed change is that the full retirement age will creep up another two months to 66 years and 10 months for folks born in 1959. But there are five other possible changes to Social Security that could come to fruition in 2021, depending on inflation, among other factors.
1. A "raise" for Social Security beneficiaries?
Make no mistake about it, the biggest change that Social Security's 64-million-plus beneficiaries would like to see happen is a cost-of-living adjustment (COLA). Think of COLA as the "raise" that beneficiaries receive most years to help them keep pace with the rising cost for goods and services (i.e., inflation).
Since 1975, the Consumer Price Index for Urban Wage Earners and Clerical Workers has served as Social Security's inflationary tether, and in all but three of the past 45 years (2010, 2011, and 2016), beneficiaries have received a COLA. It's possible that 2021 could represent just the fourth instance of deflation in over four decades.
The coronavirus disease 2019 (COVID-19) pandemic has led to an increase in medical care and food inflation but drained the life of out of energy, transportation services, and apparel, among other spending categories. At this point, it's just too early to tell if Social Security recipients will receive a raise next year.
If there's a small sliver of hope, it's that inflation perked back up in June after three consecutive months of deflation tied to COVID-19. Nevertheless, even if beneficiaries receive a "raise" in 2021, expect it to be historically small.
2. An increase in the payroll tax cap
Another potential change to Social Security in 2021 could be in the payroll tax earnings cap. The 12.4% payroll tax on earned income (wages and salary, but not investment income) is Social Security's workhorse. Last year, it was responsible for $944.5 billion of the $1.06 trillion in revenue for the program. But not all income is hit with this tax. In 2020, earned income between $0.01 and $137,700 (this is the payroll tax cap) is applicable, with earnings above $137,700 exempt.
Every year, the payroll tax cap rises on par with the National Average Wage Index (NAWI). If the NAWI rises, say, 3.6%, then the payroll tax cap will increase by the same percentage amount. Estimates for the upcoming year have called for a 3.1% increase in the NAWI.
However, the payroll tax cap doesn't increase in years where there's no COLA. So this change will be entirely dependent on whether or not Social Security's beneficiaries receive a raise. We'll know the answer to that in a little over two months.
3. A shift in the maximum monthly payout at full retirement age
High-income retirees are also likely to see their maximum monthly benefit at full retirement age adjust in the upcoming year. I say "likely," because the maximum payout at full retirement age has not been the same from one year to the next in at least 33 years (Social Security data goes back to 1987).
In 2020, for the first time ever, the well-to-do saw their maximum monthly benefit at full retirement age top $3,000. In fact, maximum benefits at full retirement age have surged by $324 a month over the past three years ($2,687 in 2017 to $3,011 in 2020).
Assuming there's a change in the maximum initial payout, history suggests that the move will result in a larger benefit. Only once in the past 33 years (2016) has the maximum benefit payable at full retirement age declined from the prior-year period. It actually rose in 2010 and 2011, which were two years where no COLA was passed along to beneficiaries due to deflation.
4. Higher withholding thresholds for early filers
Yet another change that's contingent on there being a COLA in 2021 is a possible increase in the withholding thresholds associated with the retirement earnings test.
People who file for Social Security benefits prior to reaching their full retirement age are subject to a handful of disadvantages. Perhaps none is more of a bummer than the retirement earnings test, which allows the Social Security Administration to withhold some or all of an individual's benefits if they earn over preset thresholds.
For beneficiaries who won't reach full retirement age in 2020, their maximum earning threshold before withholding kicks in is $18,240, or $1,520 a month. For every $2 in earnings above this level, $1 in benefits will be withheld. As for early filers who will reach full retirement age in 2020, they're allowed to earn $48,600 ($4,050 a month), with only $1 withheld for every $3 in income above this level.
In years where COLA is positive, these thresholds increase. But in years where no COLA was passed along due to deflation (2010, 2011, and 2016), these thresholds remained static from one year to the next. The October COLA announcement will certainly tell the tale on withholding guidelines for 2021.
5. Work credits could be a bit tougher to earn
Finally, it's possible that Social Security work credits could require a little more effort to earn in 2021.
Despite what you might have heard, you aren't simply given a Social Security retirement benefit for being an American. Instead, you have to earn it through years of work. Once you've reached 40 work credits, you've assured yourself a Social Security benefit during retirement.
The thing is, a maximum of four credits can be earned per year, which means you'll need to work at least 10 years to receive a retirement benefit. The good news is the bar to earn these credits is set pretty low. In 2020, a quarter of coverage is earned for every $1,410 in earned income. Thus, $5,640 in earned income would max out a workers' Social Security credits this year.
With the exception of 2011, the amount of earnings needed to earn one quarter of coverage has increased every year since 1978. Generally, as long as the NAWI rises from one year to the next, workers will be counted on to make a little bit more in the subsequent year to earn Social Security credits.