Fixing Social Security
The sooner Congress acts to shore up Social Security, the more time it will have to spread out tax increases or benefit changes, potentially easing the burden on younger generations who will shoulder most of the load.
“This is a problem that policymakers have known about for decades, but it has been much easier to kick the can down the road than to make difficult and generally unpopular decisions,” says Shai Akabas, director of economic policy for the Bipartisan Policy Center.
The last time Congress passed major Social Security reforms, in 1983, the program’s trust funds were just three months from running out of money.
Plus, the government has more-pressing issues at hand as it grapples with the effects of the coronavirus pandemic. And the trust fund that pays for Medicare Part A will run dry in 2024 — much sooner than Social Security’s expected depletion date of 2034 — according to predictions from the Congressional Budget Office.
“I don’t foresee Social Security being a top issue on the agenda for the incoming presidential administration,” Akabas says.
One issue likely to soon get bipartisan support: boosting benefits for people born in 1960, who turned 60 last year. To determine benefits, Social Security averages a worker’s 35 years of highest earnings and adjusts them for average growth in wages until the year the worker turns 60. Because the recent economic downturn caused a significant decline in average wages, people born in 1960 are facing a permanent benefit cut of about 5%, says Alicia Munnell, director of the Center for Retirement Research at Boston College.
“I don’t think anybody will let that happen,” she says.
President Joe Biden also has proposed changes that would expand benefits for some. For example, for those who spent at least 30 years working, Biden wants to establish a minimum benefit of 125% of the poverty level.
He also supports increasing benefits for surviving spouses. Currently, when one spouse dies, the other receives 100% of the highest benefit available to either of them. For a couple who had similar lifetime earnings, household benefits can drop by as much as half when a spouse dies. Biden would raise the monthly payout for widows and widowers by about 20%. And, to protect aging beneficiaries at risk of outliving their savings, Biden would provide higher monthly checks to those who have been receiving benefits for at least 20 years.
Q: My wife and I just received our second stimulus payment. It was transferred directly into our checking account. The deposit date is Jan. 4, 2021. Should we report this on our 2020 or 2021 tax return?
A: Stimulus payments are not taxable, so you don’t have to report it as taxable income on either your 2020 or 2021 return. That said, even though the deposit was made in 2021, you will need to factor in the amount you received to calculate your Recovery Rebate Credit, which is a special credit that only applies to the 2020 tax year. Like the first one, the second stimulus payment is considered an advance on that tax credit. The IRS estimated how much stimulus you were owed based on your 2019 adjusted gross income (2018 AGI was used for first-round payments if you didn’t file a 2019 return). If you are owed more money based on your 2020 income, you will get it as part of your tax refund. If you received more than you should have, you do not have to return the difference.
Q: Some time ago, you wrote about converting traditional IRAs to a Roth. Then I saw that the IRS refers to something called a Roth recharacterization, which is no longer allowed. What is the difference between a Roth conversion and a Roth recharacterization?
A: A Roth conversion is transferring existing funds from a traditional IRA to a Roth, a move the IRS allows, though there are tax consequences to consider. You’ll get the benefit of withdrawing that money tax free in retirement, but the downside is that you will owe taxes on the conversion amount now.
The recharacterization you refer to is reversing that conversion. For example, if you converted traditional IRA money to a Roth but then changed your mind, you can’t undo that conversion by “recharacterizing” the funds, something that was permitted before 2018. Now, when you convert the funds to a Roth, the decision and the tax consequences are final. The IRS, however, does still permit an annual IRA contribution to be recharacterized. Recharacterizing in this instance means redesignating some or all of the contribution, plus earnings, as either a Roth or a traditional IRA deposit, with the transfer completed by that year’s tax-filing deadline, including extensions.
The recharacterization is nontaxable, though you will need to report it and perhaps file an amended return.