Expecting a Social Security Fairness Act Benefit Boost? Watch Out for Tax Traps.

As both sources note, the Social Security Administration is still evaluating how to implement the law, with changes expected to take as long as a year to fully implement. But there’s now no doubt that benefits will eventually increase for millions of Americans.

Bigger checks could allow some retirees to meaningfully improve their retirement security and standard of living, but there are also important questions to be asked about shifting tax burdens, updated income assumptions and higher Medicare-related costs.

In speaking with affected clients about their bigger checks, advisors must keep the bigger picture in mind, both sources warn. That way, they can help ensure that no unexpected surprises spoil the fun of a long-awaited benefit boost.

New Taxes and Surcharges

“As with all aspects of Social Security, the higher benefits should not be looked at as money in the bank,” the HealthView Services paper states. “Unless taxation is eliminated on Social Security, increases in benefits may lead to some falling into higher tax brackets, as well as being subject to higher Medicare Part B & D income-based surcharges.”

These surcharges, known as the Income-Related Monthly Adjustment Amount (IRMAA), are added to Medicare Part B and Part D premiums for people with incomes above a certain level. They can increase monthly premiums, which are deducted from Social Security checks, by anywhere from 35% to over 200%.

While clients will likely enjoy higher benefits overall even as they pay such surcharges, the commensurate deductions will be more painful if they are unexpected.

Next, Rizzuto offers, advisors and clients must not forget about the taxation of benefits.

Taxation is based on provisional income, he explains, which is calculated as adjusted gross income plus one-half of Social Security benefits plus tax-exempt interest. Up to 85% of provisional income can be taxable.

Notably, while Social Security benefits are indexed to wage growth and adjusted for inflation, the income thresholds used to determine the taxable amount of Social Security benefits are not. In fact, they haven't been modified in decades.

Currently, married couples filing jointly only need to have a combined provisional income of $44,000 or more to subject up to 85% of their benefit to income tax.

Updating the Financial Plan

Such questions about taxation and higher income lead to another issue, Rizzuto observes, which is that of reviewing and possibly updating a client’s overall financial plan.

“An increase in monthly Social Security benefits could mean tens if not hundreds of thousands of dollars in [added] lifetime income,” he notes. “This, in addition to the taxation of benefits, could also lead to changes in withdrawal sequencing as well as investment allocations for traditional IRAs and other types of accounts.”

Finally, Rizzuto says, this extra income should lead to a review of a client’s retirement goals. Higher benefits, while raising tax questions, may open up the opportunity to fund new and different types of goals and help increase one’s overall enjoyment of their retirement years.

“The choices clients make about Social Security benefits are specific for each and every client and couple,” Rizzuto concludes. “Providing the details and considerations necessary to make informed decisions and get the most out of the system is a significant value-add financial advisors can offer to clients.”

The Biggest Impact, by State

In addition to sharing these planning considerations, Rizzuto’s review also includes an embedded graphical analysis produced by the Social Security Administration that shows a state-by-state breakdown of the approximate number of beneficiaries who have been affected by the now-defunct WEP and GPO.

Interestingly, the number of affected workers does not necessarily correlate with state population sizes, underscoring the way the public-sector workforce varies as a percentage of each state’s overall labor market — as well as the fact that each state and local government has nuances regarding the taxation of public-sector wages with respect to Social Security withholdings.

Despite being a modest-sized state, for example, Alabama has by far the highest number of affected beneficiaries, with 17,564 people having benefits cut from the WEP and 734,601 people having benefits cut due to the GPO in 2023. The total of 752,195 affected beneficiaries is more than double the number of affected beneficiaries in California (286,435) and Texas (215,183) combined.

Other states with higher numbers of affected beneficiaries include Colorado (175,447), Ohio (162,230), Oklahoma (119,113), Utah (114,122), Florida (111,733) and Illinois (104,802). States with the lowest numbers of affected beneficiaries include Vermont (5,584), Wyoming (6,250) and Nebraska (7,015).

The Overall Funding Picture

While the new law increases benefits for about 3 million public-sector employees, it will have a detrimental impact on the Social Security program’s solvency. With WEP and GPO out of the picture, the insolvency date is now as close as 2031, according to HealthView Services, depending on the exact assumptions used.

“Without changes to address the shortfall, the program will only have the capacity to pay 79% of benefits to current beneficiaries,” the paper warns. “Increasing benefits payments will raise pressure on the program, the likelihood of cuts, and the urgency to implement changes.”

The bottom line is that advisor-client conversations about higher retirement income also need to consider Social Security’s current funding challenges and the potential for changes to the program that will be required to ensure its solvency.

“These will one way or another include direct or indirect cuts to benefits detailed in our 2024 Social Security Funding white paper, which are made more urgent with every additional unfunded increase in benefits or potential reduction in taxes,” the paper concludes. “Some financial professionals may consider viewing only a portion of projected Social Security income for planning purposes, reducing expected benefits by 10%, or as much as 21%, to account for potential reductions due to solvency challenges.”

Pictured: John Manganaro