Lost in the ocean of billions of dollars from the recent financial scandals and disasters has been the illegal practice of banks garnishing Social Security and disability payments for third party creditors.

Social Security beneficiaries have had the above-mentioned $171.4 million taken from their account that received direct deposits, plus $6.3 million more from accounts that contained only Social Security benefits.

There was been very sparse media coverage of the findings of an investigation conducted by the Inspector General (IG) of the Social Security Administration (SSA). Those findings were published earlier this month in the CONGRESSIONAL RESPONSE REPORT: Financial Institutions Deducting Fees and Garnishments From Social Security Benefits (PDF, 45 pages).

The fee reference, by the way, was the IG’s finding that in some cases banks would freeze accounts and charge penalty fees after the freezes – in excess of $1 million just between September 2006 and September 2007.

It’s just a drop in the bucket of the billions mentioned above, but not if you were one of the Social Security beneficiaries affected. And as mentioned above it’s illegal.

The Social Security Act (Act) provides that

The right of any person to any future payment under this title shall not be transferable or assignable,7 at law or in equity, and none of the monies paid or payable or rights existing under this title shall be subject to execution, levy, attachment, garnishment, or other legal process, or to the operation of any bankruptcy or insolvency law.

There are five exceptions, however, which does not include the garnishments currently being done. The Act:

  1. Allows the enforcement of child support and/or alimony for the support and maintenance of a child subject to, and in accordance with, State or local law.
  2. Allows the Internal Revenue Service to collect unpaid Federal taxes.
  3. Allows beneficiaries to elect to have a percentage of their benefits withheld and paid to the Internal Revenue Service to satisfy their Federal income tax liability for the current year.
  4. Allows benefits to be withheld and paid to another Federal agency to pay a non-tax debt the beneficiary owes to that agency.
  5. Authorizes the Internal Revenue Service to collect beneficiaries’ overdue Federal tax debts by levying up to 15 percent of each monthly payment until the debt is paid.

So how is the Act enforced? Not very much. The SSA interprets the Act such that its responsibility ends when it pays the beneficiary. And there are very few states that do offer protection: California and Connecticut. The Governor in New York is expected to sign a bill that is similar to the one in those two states. It would protect up to $2,500 of a depositor’s account from being frozen if benefits are being received via direct deposit.

My suggestion to fix the problem? Impose that same standard of non-alienation or assignment of benefits as is required under ERISA. Beneficiaries should be treated as beneficiaries!

Postscript: One of the few financial writers to pick up on the IG’s report was Laura Rowley who wrote in her July 16, 2008 column for Yahoo!(R) Finance that Banks Continue to Prey on Social Security Recipients. She was also way ahead of other financial reporters in her November 15, 2007 column, Unholy Alliance Fleeces Social Security Recipients. Ms. Rowley’s column is called Money & Happiness, the same name as her blog and book. And finally, a hat tip to My Retirement Blog (no relation) for their post on this subject.