5 Social Security Myths -- Debunked!

By Matthew Frankel Markets Fool.com

Social Security is the most widely used retirement and disability insurance program in the United States. In fact, there are currently 66 million Social Security beneficiaries, and this number is expected to rise in the coming decades as the baby boomer generation reaches retirement age. Unfortunately, Social Security isn't as well-understood as it should be. Here are five common Social Security myths -- and some facts to set the record straight.

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1. "Social Security is bankrupt"

This one is simply not true, but it's perpetuated by many misinformed people.

Social Security is actually in decent financial shape for the time being. The trust funds had more than $2.8 trillion in reserves as of the end of 2015, and they're expected to run a slight surplus through 2019. In 2015, for example, $23 billion more flowed into the system than was paid out as benefits.

The bad news is what happens after 2019. Annual deficits are expected to begin in 2020 and increase rapidly, depleting the trillions in reserves. If the current projections are correct, Social Security will run out of money by 2034.

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There are two extremely important facts all Americans should know. Social Security will have enough money to pay out 100% of its promised benefits for another 17 years. It is not broke, and there is plenty of time to fix the problem. Second, if the system does run out of money in 2034 as expected, then incoming tax revenue would still cover more than three-fourths of the promised benefits. This would be the worst-case scenario.

2. "I'll get more money by waiting to claim my benefits"

While it's true that your monthly benefit checks will increase if you delay retirement, it's a myth that you're likely to get more money altogether by waiting.

In fact, the whole reason early retirees get smaller checks while those who delay benefits get larger checks is so that the average person gets the exact same amount of money from Social Security during their lifetime.

I'll spare you the mathematical details, but just to give you an idea, let's say your full retirement age is 66 and your primary insurance amount (PIA) -- i.e., the retirement benefit you're entitled to at your full retirement age -- is $1,500 per month. Waiting until age 70 to claim benefits would increase your check to $1,980 per month, but you'd also miss out on four years of income. Conversely, claiming at 62 would reduce your monthly checks to $1,125, but you'd have an additional four years of income.

Based on the Social Security Administration's life expectancy tables and projected inflation rates, the lifetime expected total benefits are within a few hundred dollars of each other, regardless of when you claim.

3. "I can't work and collect Social Security"

This isn't true, but depending on your age, your benefits can be reduced if you earn more than a certain amount. The SSA applies an "earnings test" to workers which groups beneficiaries into three categories:

  • For beneficiaries who will reach full retirement age after 2017, the earnings threshold is $16,920. For every two dollars in earnings beyond this threshold, one dollar in benefits will be withheld.
  • For beneficiaries who will reach full retirement age during 2017, the threshold is $44,880 for the year, or $3,740 per month. The test is only applied in months before the month full retirement age is reached, and every three dollars in excess earnings will result in a one-dollar benefit reduction.
  • Finally, beneficiaries who are at or beyond their full retirement age are free to work and earn as much as they can, without any reduction to their Social Security benefits.

It's also important to mention that although benefit checks can be reduced under the earnings test, any reduction will lead to a permanent increase in your future Social Security benefits. You may not fully reclaim your forfeited benefits, as there's no guarantee you'll live long enough. But the point is that these benefits aren't necessarily lost; you may get them back eventually.

4. "Only my last few working years determine my benefit"

In many private- and public-sector jobs that still have pension plans, the amount of the retirement benefit is typically based on the last few years of earnings. For example, as a part-time teacher, I'm in my state's retirement system, and my benefit will be calculated as a percentage of my last three years of earnings, averaged together.

The same concept does not apply to Social Security benefits. Instead, Social Security is designed to take most of your working life into account. Specifically, every year you earned money is indexed for inflation (up to each year's taxable maximum), and your top 35 years will be considered when calculating your average earnings.

5. "Social Security benefits are tax-free"

Many people don't have to pay any income tax on their Social Security benefits. However, if you have significant taxable income in addition to your Social Security benefits, up to 85% of your benefits could be subject to tax.

To determine if any of your Social Security benefits are taxable, the IRS considers your "combined income," which is your adjusted gross income (AGI) plus any nontaxable interest income and half of your Social Security benefits. Depending on your combined income and tax filing status, you can fall into one of three categories:

  • None of your Social Security benefits are taxable.
  • Up to 50% of your Social Security benefits are taxable.
  • Up to 85% of your Social Security benefits are taxable.

No matter how much you make, no more than 85% of your benefits will be taxable. For the 2016 tax year, the thresholds are:

Taxable Benefits Category

Combined Income (single filing status)

Combined Income (married filing jointly)

Benefits are not taxable

Less than $25,000

Less than $32,000

Up to 50% of benefits taxable

Between $25,000 and $34,000

Between $32,000 and $44,000

Up to 85% of benefits taxable

More than $34,000

More than $44,000

Source: Social Security Administration. (Note: If you are married and file a separate tax return, you'll probably pay taxes on your benefits, regardless of your combined income.)

The bottom line is that you're probably going to collect a Social Security benefit at some point in your life. The more you know about how Social Security works, the better you'll be able to plan for your own retirement and make informed decisions about your benefits when the time comes.

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