The ups and downs (mostly downs) of the stock market have been on everyone's mind since 2016. Ah, but you're receiving a lot of your income from Social Security so you don't have to worry: Your benefits are secure from the market's roller-coaster ride. Or are they? Can the stock market impact your Social Security checks?

How It Works

First, some basics. Your benefits are paid out of the reserves of the Social Security Trust Fund.  Money in the trust fund (which actually consists of two funds: the Old-Age and Survivors Insurance Trust Fund and the Disability Insurance Trust Fund) comes from payroll taxes collected from workers and employers (you remember that category marked "FICA deductions" on your pay stub); people who are self-employed contribute too, in the form of the self-employment tax So your benefits are being funded by contributions from those in the workforce, along with the investment earnings generated on those contributions and federal income taxes.    

Now, about those investment earnings. The Social Security Trust Fund has no direct connection to the stock market. On a daily basis, funds left after payment of all benefits are invested in special-issue government bonds. They are similar to U.S. Treasury bonds, except that they don't trade publicly. These interest-bearing bonds are a form of IOU, to be paid from future FICA tax receipts. 

For details, see: How Is The Social Security Trust Fund Invested?

Stock-Oriented Scenarios

Your individual Social Security benefits are determined in much the same way a defined benefit pension plan works. The amount you receive is based, in part, on how long you worked and how much you earned during your working lifetime (the full formula appears here). None of the calculations that go into determining your benefits have anything to do with the stock market, bond market or the prime interest rate, either. (For more on the fundamentals, see 10 Social Security Questions Everyone Asks.)

However, there is a way the stock market could affect your Social Security benefits. This would be if you opted to start taking them before full retirement age (currently 66 for most people) and, at the same time, exercised non-qualified employee stock options (NSOs). Profit generated by the exercise of those options is considered work or earned income. If your total work income for the year, including profit from the sale of NSOs, is more than $15,720 (in 2016), your benefits will be reduced by $1 for every $2 over the limit.

This only applies to NSOs, however. Profit from exercised stock options bought on the open market or from employer-granted incentive stock options (ISOs) are considered capital gains, not earned compensation. As such, they do not affect your benefits so long as you have held those options for at least a year.

Tax Consequences

Once you reach full retirement age, no amount of income, no matter the source, has an effect on the amount of your Social Security benefits. However, if at any age your total reportable income (including interest payments, dividends, stock options, capital gains and any other investment-related items) exceeds a certain amount, a portion of your Social Security benefits may be considered taxable as well. So, ironically, a great year for the market, and your portfolio, could effectively reduce your benefits – by imposing taxes on them. (Even so, there are ways to Avoid the Social Security Tax Trap.)

The rules for determining whether your Social Security benefits are taxable are explained here. In general, you should not have to pay federal income tax on more than 85% of your Social Security benefits. In all likelihood, the percentage would be lower. 

Other factors, including the age at which you begin receiving benefits, your work history and any additional income you receive while getting benefits can directly or indirectly affect your Social Security bottom line. If you receive a government pension, it could result in a reduction of your benefits through either the Government Pension Offset (GPO) or Windfall Elimination Provision (WEP).

A Modest Proposal

So basically, Social Security's exposure (and yours, as a benefits recipient) to the stock market is pretty limited. Ironically, that could soon change.

The well-known, well-publicized funding crisis that surrounds the Social Security Trust Fund – the fear that Social Security will go bankrupt, especially as the bulk of the huge Baby Boomer generation retires and starts collecting (see Americans Are Living Longer, but Social Security Is Not Catching Up) – has generated much discussion about finding better ways to finance the program. One suggestion involves investing all or part of the Social Security Trust Fund in the equities markets. Another argues for allowing individual workers to invest all or part of their FICA contributions in instruments of their choosing (much as they can direct their 401(k) contributions to mutual funds now).

While some observers insist it’s time for Social Security to invest in the market – or allow employees to do so – and take advantage of the higher rates of return that would be possible, others warn that involvement in the stock market would not make a difference and could, in fact, insert an element of danger in the event the market collapses or enters a prolonged bear period. Presumably, the trust fund would be a conservative investor, opting for the safest blue-chip stocks, but some degree of risk always exists when investing in equities.

The Bottom Line

If you're worried that stock-market slumps can affect your Social Security benefits, the short answer is no. For the most part, it’s fair to say the performance of the stock market has no direct impact on your Social Security benefits. In certain limited situations, sizeable investment gains from the market could decrease your benefits, or cause them to become taxable.

Should the Social Security Trust Fund begin investing in the stock market, or allowing workers to do so with their contributions, there would be no doubt that market results – good or bad – would have a direct effect on Social Security benefits. While there are no definite plans for that to happen, it can serve as a reminder (as if you needed one) that you should have your own personal retirement accounts in place, too, and not rely just on a government nest egg.

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