The relationship between the stock market and your monthly Social Security check should be on your mind. In certain limited situations sizable investment gains from the market could decrease your benefits or cause them to become taxable. Like most investment advice, careful planning and a thorough understanding of the rules help to ensure that your benefit checks don’t dwindle.
- Social Security does not invest any of its funds in the stock market, so stock price fluctuations do not directly impact benefits.
- A booming stock market might increase your personal retirement portfolio’s earnings and make your Social Security benefits taxable, thus reducing them.
- If you begin taking Social Security before full retirement age and exercise non-qualified employee stock options, your benefits could end up being further reduced.
How Social Security Benefits Are Generated
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 people in the workforce, along with the investment earnings generated on those contributions and federal income taxes.
However, the Social Security Trust Fund has no direct connection to the stock market. Funds left after payment of all benefits are invested in special-issue government bonds on a daily basis. They are similar to U.S. Treasury bonds, except they don’t trade publicly. These interest-bearing bonds are a form of IOU, to be paid from future FICA tax receipts.
Your individual Social Security benefits are determined in much the same way that 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. 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.
However, there is a way the stock market could affect your Social Security benefits. That scenario would arise if you opted to start taking those benefits before full retirement age and at the same time exercised nonqualified 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 the legal limit, 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, as long as you have held those options for at least a year.
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. So, ironically, a great year for the market and your portfolio could effectively reduce your benefits—by imposing taxes on them.
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).
If proposals succeed that would allow either the government or individual employees to invest Social Security funds in equities markets, stock market performance will most definitely affect your benefits.
A Modest Proposal
Basically, Social Security’s exposure (and yours, as a benefits recipient) to the stock market is pretty limited. Ironically, that could 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—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.
While some observers insist that 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 that 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 that the performance of the stock market has no direct impact on your Social Security benefits.
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, the possibility 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 solely on a government nest egg.