Social Security Penalizes Two-Earner Families

Here’s something I learned from Jim Blankenship’s book A Social Security Owner’s Manual: Social Security is overly generous to one-earner families and penalizes two-earner families. Of course Jim didn’t say it directly in the book. I reached this conclusion based on the information I learned from the book.

When Social Security first started in the 1930s, one-earner families were the norm. Husband worked; wife stayed at home. Now, two-earner families are the norm: both husband and wife work full time. It’s been this way for many years, but Social Security rules stayed behind. They are still operating in the world as if one-earner families are the norm.

Consider two couples. Couple One is the traditional one-earner family. Husband worked; wife didn’t. They both reached their full retirement age at 66 this year. After indexing for wage increases and inflation, the husband’s average earnings over the highest 35 years is $48,000 a year.

Couple Two is the now-usual two-earner family. Both worked full time. Husband earned a little more due to gender wage gap; wife earned a little less. They also both reached their full retirement age at 66 this year. After indexing for wage increases and inflation, the husband’s average earnings over the highest 35 years is $25,200 a year; the wife’s is $22,800 a year.

When we add the income from both husband and wife, Couple One and Couple Two had identical income: $48,000 a year. When they filed their taxes jointly, both couples paid the same amount of income taxes. Because their incomes have been below the Social Security wage base ($106,800 in 2011), the two couples also paid the same amount of payroll tax for Social Security and Medicare.

Although both couples had identical income before and after taxes, Couple One had a better life. The husband’s higher-wage jobs had a better work environment and used more knowledge skills than physical labor. Couple One didn’t have to spend as much on daycare and after school programs because the wife had more time to take care of their children. Their children had better grades because mom had more time to help. They ate more healthily and their homes were better taken care of because the wife had more time at home. They didn’t spend as much on work clothes or commute.

Even Social Security treats Couple One better when they reached retirement age. In Social Security lingo, the husband in Couple One has an Average Indexed Monthly Earnings (AIME) of $4,000 a month. After applying the Social Security benefits formula, the husband’s Primary Insurance Amount (PIA) is $1,812 a month. His wife gets 1/2 of the his PIA. That’s $906 a month. Together, Couple One receives $2,718 a month from Social Security.

For Couple Two, the husband’s AIME is $2,100 a month; the wife’s AIME is $1,900 a month. Their PIA are $1,154 a month and $1,084 a month respectively. Together, Couple Two receives $2,238 a month. Social Security pays Couple One $480 a month or 21% more than it pays Couple Two, even though they had identical income and paid identical amount of taxes, and Couple Two had smaller personal savings due to higher expenses on child care, education, commute, etc.

The gap only grows larger after one spouse dies. If the wife dies first, the husband in Couple One continues to receive his PIA of $1,812 a month. If the wife dies first, the husband in Couple Two continues to receive his PIA of $1,154 a month. Now the difference between what the two families receive from Social Security has increased from $480 a month to $658 a month. Social Security pays the surviving spouse in Couple One 57% more than it pays the surviving spouse in Couple Two.

If the husband in Couple One dies first, his wife receives 100% of his PIA as survivor benefits. That’s $1,812 a month. If the husband in Couple Two dies first, his wife receives 100% of his PIA ($1,154 a month) as survivor benefits because it’s a little higher than her own PIA. The difference in Social Security benefits received by Couple One and Couple Two increases from $480 a month to $658 a month. Social Security pays the surviving spouse in Couple One 57% more than it pays the surviving spouse in Couple Two.

In summary:

AIME PIA Wife Dies Husband Dies
Couple One
Husband $4,000 $1,812 $1,812 $0
Wife $0 $906 $0 $1,812
Total $4,000 $2,718 $1,812 $1,812
Couple Two
Husband $2,100 $1,154 $1,154 $0
Wife $1,900 $1,084 $0 $1,154
Total $4,000 $2,238 $1,154 $1,154
$ Difference $0 $480 $658 $658
% Difference 0% 21% 57% 57%

Our one-earner family is favored left and right compared with the two-earner family with an identical household income. They accumulate more savings when they worked, due to lower expenses on child care, education, and many other things. They receive higher Social Security benefits when they retire. When one spouse dies, Social Security favors them yet again.

Is there a good policy reason that one-earner families must be favored over two-earner families? I don’t see any. The only reason I can think of is that the rules were set when one-earner families were the norm. Nobody bothered to think about two-earner families because there were so rare. Once the rules were set, they became entrenched. Nobody dared to touch the third rail.

Social Security benefits are overly generous to one-earner families. When Social Security is facing funding problems, this would be a good area for reform. Treat each person as an individual. Let their benefits be driven by their own earnings record. Get rid of the spousal benefits. When one spouse dies, reduce the benefits to one half of what the couple used to receive. That’s pretty much how a two-earner family would be treated. Make it consistent for one-earner families as well.

Removing the spousal benefit will also practically end the game people play with how they claim the benefits such as file-and-suspend. When Social Security faces funding problems, we can’t afford these games.

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Comments

  1. Jay says

    I know you are just focusing on social security … but since you opened the door to the “spouse working or staying home with the kids” dilemma , perhaps an article on how our tax system allows two wage earners to deduct child care costs, but provides no corresponding tax benefit to the spouse who chooses to provide that child care themselves … at the significant “child care cost” of lost income.

    Perhaps the SS benefit you discuss should be left as is.

  2. says

    @Jay – As you must know, a tax deduction on a cost incurred is worth much less than the cost itself. Compare Couple One and Couple Two in this post when they are raising their kids. Say Couple Two pays $5,000 a year in child care expenses. They get a tax deduction perhaps worth $1,000. They are still out $4,000. With the same combined income, Couple One is much better off with not having that deduction.

  3. David says

    I think the better solution is to increase the two-earner benefits to match the one-earner benefits. The financial problems in SS are much less than the pundits make out. With a 75 time horizon, even minor changes now can have a very big effect on the end result. Meanwhile, something like 3/4 of retired families rely almost exclusively on SS benefits. They aren’t rich, let me tell you. Reducing benefits would cause way more human suffering than the alternatives.

  4. says

    @David – With the Social Security funding problems, whether they are more or less than the pundits make out, the future generations will already receive a smaller benefit relative to the current and previous generations. Increasing the two-earner benefits will only tilt it even more toward the current generation at the expense of the future generations because the future generations will pay for it and the current generation of recipients will benefit from it and not pay for it.

  5. Ace says

    You asked if there is a good policy reason that one-earner families be favored over two-earner families. You gave the policy reason in your article: “Couple One didn’t have to spend as much on daycare and after school programs because the wife had more time to take care of their children. Their children had better grades because mom had more time to help. They ate more healthily and their homes were better taken care of because the wife had more time at home.”

    I realize this may be politically incorrect and “old-fashioned,” but remember that once upon a time our tax and welfare laws weren’t just created to redistribute wealth and try to narrow the gap between rich and poor. Once upon a time they were also created to promote positive social policies, reward “good’ behavior, and deter “bad” behavior. The mortgage and charitable deductions were put into place because home ownership and supporting charity is “good.” Tuition credits and deductions are there because education is “good.” Cigarette taxes exist because smoking is “bad.”

    Statistics show (and you state in your post) that children do better and families are stronger when one parent (either parent) stays home full-time. I realize this is always possible, but I do think it is something our society should aspire to and promote as “good.” The existing social security system you outline promotes this policy, and also recognizes that stay-at-home moms and dads provide invaluable service to their families and communities, even though they don’t get a paycheck that plugs into the social security formula.

  6. Rabbmd says

    The one benefit to two working families is the ability of both to deduct $16,500 this year under 50 to deferred comp plans like 401ks, 403bs. That is the one benefit my wife quit her job a couple years ago in a very similar situation to the one whitecoat described.

  7. Andrew says

    “Removing the spousal benefit will also practically end the game people play with how they claim the benefits such as file-and-suspend.”
    I definitely agree that this fix would end some of the games people play and we absolutely need to make some fixes to Social Security.

    But there is a problem with treating each person as an individual and letting their benefits be driven by their own earning record. With the high divorce rates, what happens if the divorcee has a low earning record because he/she stayed at home with the kids. Your solution is fine and fair if the couple were still married and they have both social security benefits to draw from, but would be unfair to the stay-at home spouse if they eventually divorces the sole wage earner

    • TFB says

      Divorce settlement will take care of that. Each person has an earnings history. At the time of divorce, a percentage of one’s earnings history during the time of marriage can be assigned to another person. Canada does it this way. It’s working.

  8. Lisa says

    I always knew about the inequality problem with a single income family paying the same tax as a dual income family but enjoy much higher quality of life, but hey, taxes are never fair, someone in Austin vs someone in New York with the same income is going to have very different standard of living. However, this SS difference is far larger than I imagined and mothers don’t consider this when deciding whether to return to work. The government is basically saying mothers who earn less than $40k shouldn’t bother stepping outside their house. Might as well make all women pay out of state tuition while we’re encouraging “traditional family value”. The US system is so broken.

    Ace, if we really want to “recognizes that stay-at-home moms and dads provide invaluable service to their families” then maybe we should make them pay tax on that contribution? After all, I have to pay for cooking and house cleaning with after tax money (plus sales tax) if I want to achieve the lifestyle of a single income family.

  9. MURV says

    Even worse is the case of a family with one 48k income and one 15k income. No benefit at all for the lower income but still have to pay all the SS taxes

  10. Steve says

    Re: Lisa (6 December 2011)

    Your comment about taxing stay-at-home moms and dads really has me baffled.

    Taxes are implemented by the government for two base reasons: 1) to generate additional revenue (without having to actually create anything); 2) To modify people’s behavior by making them pay to participate in an activity frowned upon by the government.

    So, which way were you going with your comment… just more money to be forcibly taken from us, by the gov’t… or do you disagree with the notion of one parent being present in the home, to raise the children? A notion, by the way, which has proven rather effective for a pretty long time (at least a couple of hundred years)…

  11. ND says

    I see no reason for taxpayers to subsidize sole-breadwinners. There is lots of evidence that children do best in homes where both parents work for pay and both parents do the unpaid work of family life, child care, parenting etc. Some 2-earner/2-parent families do this with no outside child care (working 30-hour weeks for example, on staggered schedules), or if they do childcare, it is paid for by the parent outsourcing his/her share of the care.

    I think that Social Security and Medicare should be made neutral as to family structure.

    I also think the income tax code in general should be made individual and not joint filing. Children can be claimed half on each parent.

    We need a progressive federal income tax code, though, because property and sales taxes are regressive by their nature.

  12. says

    ND – Thank you for pointing out the study. The scenario P2 in the study looks good to me. It takes care of the survivor benefits. This shows they know the problem and how to solve it. They just lack the political will to touch the status quo. As a result, more affluent one-earner families continue to benefit over less well-off two-earner families.

  13. Tony Naples says

    The comparison is not the same. Generally the same would be for a family with two earners versus one earner with same education and earning ability. The one earner couple loses the added income. They don’t gain anything. In other words your two -earner couple should have one spouse making $48K same as one eanrer couple plus the second spouse earning ?? $36K. Now you have the more realistic situation. In this case the two-earner couple must pay for child care and other expenses, but the govt (one earner couple) subsidizes by offering credits for child care.
    The fact remains that stay at home spouses do work that is essentially unpaid. Child care is working. Cooking and cleaning are working. All three activities are unpaid positions in one-earner family.
    The problem can be viewed from a variety of lenses. At the end of the day the system no matter how hard we try will never be completely equal. Is it unfair? I can’t answer that question. Families, parents, spouses and single people who choose not to get married all make lifestyle choices.Expecting the tax code to effectively deal with those choices in a changing society is unrealistic. Add in the cost of health care, how health care is dleivered and the issues of medicare and now the problem is much more complex.

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