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This year, 178 million workers and their employers will pay over $1 trillion in Social Security taxes to support 65 million retirees.
The subject is dreadfully dull, confusing, and complicated. It’s also one of the most important retirement subjects you need to know and understand clearly. Mistakes can be costly and irreversible. And you should get every penny you deserve.
This article condenses the most important information you need to know and shares an abundance of charts and graphs to help you understand how you compare to the rest.
A brief history
The Social Security Act of 1935 was a reaction to the economic devastation in the years following the Great Depression. It was signed into law by President Roosevelt and was originally designed to augment the patchwork of ineffective welfare programs and provide economic security for retired workers aged 65 and older (and soon after, families and the disabled).
“We can never insure one hundred percent of the population against one hundred percent of the hazards and vicissitudes of life, but we have tried to frame a law which will give some measure of protection to the average citizen and to his family against the loss of a job and against poverty-ridden old age.”
—President Roosevelt upon signing Social Security Act
There is an important lesson in Roosevelt’s quote: You must not expect Social Security to provide all your financial security in retirement. It is incumbent upon you to prepare responsibly for your own retirement.
Important Tip: Save, plan, and then save some more.
How Social Security works
There are three main types of Social Security benefits:
- Retirement benefits: For qualifying individuals age 62 and over
- Disability benefits: For individuals at any age who meet specific disability criteria
- Survivor benefits: Relatives may receive a portion of the decedent’s benefits
This article focuses on Retirement benefits, so the following information relates to that.
Benefits are funded by you and your employer. The government takes 6.2% of your income and an equivalent amount from your employer. This is a pay-as-you-go program, so the money is not saved for your personal use, rather it is used immediately to fund the benefits of current recipients. In the future, when you take your benefits, they’ll be funded by active workers at that time.
For many years, more was paid into the system than paid out, and a surplus of almost $3 trillion dollars had been set aside (often referred to as the “Trust Fund”). Now, due to the volume of baby boomers retiring, fewer workers are paying into the system and the surplus is being tapped to pay benefits. It is projected to run dry in 2034 and if nothing is done, your benefits will be reduced (see ‘insolvency’ below).
How much will you get?
The most you could receive per month if you retired in 2020 is $3,011. The average is about $1,500. To find out exactly what your benefits will be at different ages, go to https://www.ssa.gov/myaccount/ and check your account.
How it’s calculated:
To qualify for any benefits at all (other than a few exceptions) you must have worked and paid into the system a minimum of ten years.
The government considers two factors when calculating your benefits:
- Your work history, specifically your 35 top-earning years.
- The age you elect to receive payments, between age 62 to 70.
The higher your income, the higher your benefits, but the younger you take you benefits, the less you’ll receive. For the average recipient, Social Security benefits provide just 40% of their living expenses.
Here’s a distribution of how much people receive:
Important Tip: Working a few extra years at career-high income levels will improve your 35-year average and result in higher benefits. If you’ve worked for fewer than 35 years, any income will increase your benefits.
When is the BEST time to take SS?
You can elect to receive benefits between age 62 and 70.
The age you choose is a personal decision. Take your time to consider it carefully because you generally don’t get second chances. A good rule of thumb is to take it as late as you can afford to so you can receive the highest monthly amount possible. Every year you wait past your FRA, your benefit amount grows by 8%.
FRA = “Full Retirement Age”
Your benefits are tied to a specific age, which varies based on your birth year. Use this chart to find your FRA:
The value of waiting
Statistically, an average retiree would receive the same lifetime benefits regardless of when she chose to start taking them. Smaller amounts for longer periods equal larger amounts for shorter periods. If you live longer than average, however, waiting is your best bet. If you expect a short retirement, you’ll be better off starting sooner.
If you don’t know how long you’ll live, the smartest gamble is to wait as long as you can.
This chart shows the different benefit amounts compared against a $1,000 FRA benefit.
The following chart is a different view of the value of waiting. Waiting until age 70 boosts your monthly benefit by a whopping 32%. Taking it right away costs you 25% – every month for the rest of your life.
When do most people take benefits?
90% of all individuals age 65 and older receive Social Security benefits. More than a third of them chose to receive benefits at age 62. Full Retirement Age of 66 is another popular time to sign up, but very few wait it out beyond that to get the highest benefits possible.
Those who were already receiving disability see an automatic conversion from disability benefits to retirement benefits at their FRA.
Warning: Under most circumstances, if you elect to start receiving benefits, you’re stuck with that for the rest of your life.
Will your benefits increase over time?
Yes, but don’t get too excited. Your benefits may increase annually via a Cost of Living Adjustment (COLA), but the last 30 years have shown significant variances – from 0% to 5.8%.
COLA adjustments are tied to the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). They’re trending down and may be at risk of further reductions in the coming years due to the impending insolvency crisis (more on that below).
How much is that in real dollars?
If you retired and were receiving $550 a month in 1990, 30 years later, your benefits would now be $1,073, about twice the original amount.
While your income doubled over those 30 years the S&P 500 index grew 10 times more than the original amount.
Important Tip: Don’t put all your eggs in the Social Security basket.
Is Social Security taxable?
Since 1984, recipients with incomes above certain thresholds have been subject to federal income tax. At first, only 1 out of 10 recipients met the taxable threshold, but these days more than half will exceed it.
Federal income tax on Social Security earnings go directly back into funding the program, and last year totaled $37 billion, or 3.4% of the total revenue.
The method of calculating how much your benefits will be taxed is a lot like rocket science, so be sure to consult with a tax advisor. In short, there are three tiers of taxation as shown in the chart below. The concept of “combined income” is where it gets tricky, as only half of your benefits are considered in that equation. Here’s a link to the IRS instructions if you’re a masochistic math fanatic.
In addition to federal taxes, 13 states may tax your benefits as well. They are: Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Utah, Vermont and West Virginia. State taxing rules vary so check with your state tax agency for more details
Can they ever reduce your benefits?
Many people supplement their income while also taking Social Security. If you do, there are important rules you need to be aware of.
If you elect to receive benefits at or after your FRA, you can earn as much as you want with no effect on your benefits.
Working and taking benefits before your FRA is different, but the rule is simple: In 2020 you will lose $1 in benefits for every $2 in wages earned above $18,240. If you have a part-time job that pays $20,240 a year (which is $2,000 over the limit), you will lose $1,000 in benefits.
This rule applies only to wages from employment, not investment income, pensions, or annuities. And the silver lining is that you don’t forfeit the money they’ve deducted, it will be added back into your monthly benefit later, so when you reach FRA your benefit amount will be higher.
What’s this I hear about Insolvency?
If our leaders continue to flail about aimlessly, Social Security will burn through its trust fund by 2034 or sooner. This doesn’t mean your payments will cease, but they could be reduced by an estimated 24%.
How could this happen? Simple, we have fewer workers to cover the benefits of retirees. Back when we had a 5:1 ratio, we set aside extra money in a trust fund. Today we have 2.8 workers per recipient, and by 2034 we’ll have just 2.3. Then, you’ll only receive 76% of your promised benefit.
I could go into an extended tirade about this, but I did that in another article where you can find a lot more detail and outrage. You can read it here.
This chart shows what will happen to a theoretical $1,200 benefit today over a 30-year period going forward (assuming a growth rate of 1.5%). Rather than doubling like the example in the “Benefit growth” section above, it will increase by only 19%.
Should you take benefits earlier because of potential insolvency?
The answer could be “yes” if you knew for a fact that the program would never be fixed. There is hope, however, that our politicians will take action soon. If they do, the deficit spending can be fixed and you can still rely on higher benefits by waiting.
Summary
Over its lifespan of 85 years, Social Security has lifted hundreds of millions of people out of poverty in old age and given them a retirement of dignity and pride. For others it has provided a cushion in their retirement that replaced financial fear with confidence and security.
It’s a complicated program replete with nuance and detail. The information presented above is intended to cut through the noise and highlight the aspects that are most important to the average retiree. Please keep in mind that the program changes annually, and your circumstances may be impacted differently than others.
So, be sure to talk to experts before making life-changing decisions. The author is not a certified financial expert, but with this article and many others hopes to make your retirement the best it can be.
You can find more articles like this on Medium at https://medium.com/life-after-work, or on the web at http://lifeafterwork.zone.
Data for all charts above came from SSA.gov and were created by the author, except Social Security Cash Flows which was from Commons and modified by the author