The potential longevity of Social Security benefits has been an issue of widespread concern, with a 2022 Nationwide Retirement Institute survey revealing that 70% of Americans fear the program may exhaust its funds within their lifetime. This anxiety is not unfounded; if the projections of the trustees of the Social Security and Medicare trust funds prove accurate, by 2034, Social Security may only be able to afford to pay 77% of the planned benefits.
But imagine if those who didn’t require Social Security could voluntarily suspend their benefits, thereby bolstering the program’s stability for those who depend on it. Such a possibility could ensure the continuity of Social Security for generations to come.
This brings us to a proposed legislation currently being discussed in the U.S. Senate, the RMD Option (The Option) Act. This act has the potential to sustain Social Security indefinitely. As it stands, over 25 million seniors aged 70 and above receive Social Security payments monthly.
Several of these seniors are legally obligated to withdraw from their tax-deferred accounts, known as the required minimum distribution (RMD), primarily so the government can classify them as taxable income. Many individuals would willingly forfeit their Social Security payments if they could defer their RMDs.
Affluent retirees who are financially secure without Social Security benefits often feel burdened by unnecessarily increasing their taxable income through RMDs. At age 73, retirees might suddenly find their tax bracket doubling or even tripling due to RMD-inflated income. This could inadvertently increase their Medicare withholdings, leading to a stealth tax. The Option provides an attractive alternative, offering a significant tax reduction opportunity. Given the benefits, it’s anticipated that many retirees would choose The Option for life, potentially saving more in taxes than their Social Security benefits would offer.
One primary advantage of this plan is the potential improvement to Social Security’s longevity if many individuals decide to suspend their Social Security payments. This would contribute billions to the Old-Age and Survivors Insurance (OASI) Trust Fund, the fund utilized by the U.S. Treasury to disburse Social Security benefits.
The RMD Option Act is voluntary, allowing individuals to return to the traditional system after a year if they so choose, with Social Security payments resuming at the suspended level, barring any cost-of-living adjustments (COLA) that occurred during the suspension. RMDs would also continue.
Implementing The Option would be straightforward, requiring only a visit to the Social Security website to make a selection. It should be noted that choosing The Option would freeze current Medicare withholdings for the suspension’s duration. Medicare premiums would cease to be deducted from the Social Security payment, and the individual would need to determine their out-of-pocket payment method.
From a taxation standpoint, 85% of a well-off taxpayer’s Social Security is taxed at their marginal bracket. Under The Option, taxable income could significantly reduce, potentially leading to substantial tax savings. Although delayed, taxes would still apply to all money held in tax-deferred accounts subject to RMDs when withdrawn. The Option also allows one spouse to receive Social Security payments while the other utilizes The Option.
With the introduction of the 2019 SECURE Act, many beneficiaries who inherit pre-tax accounts must distribute these accounts entirely within ten years, with all distributions subject to income tax. If individuals were not required to start taking RMDs at 73, these funds could grow throughout their retirement, leading to significantly larger accounts for their heirs and more tax revenue over the 10-year distribution period.
Those with higher income might find The Option more appealing if they consistently save and receive substantial Social Security payments. The ideal candidates for The Option are individuals over 70, with taxable income above $100,000, predominantly from RMDs and Social Security payments.
A simple cost-benefit analysis can reveal if The Option is beneficial. If the cost, represented by Social Security payments, is less than the benefit, the deferral of the RMD and Social Security taxes, one might choose The Option. However, finances are personal, and not all decisions are based solely on mathematical calculations.
As people age, the mandatory amount for distribution from their tax-deferred accounts increases, making The Option more appealing. Individuals choosing to relinquish annual Social Security payments could significantly contribute to strengthening the solvency of the Social Security program.