5 Things to Know Before Applying for Social Security

By Matthew Frankel Markets Fool.com

Social Security is by far the largest "retirement plan" in the United States. Virtually all American senior citizens will collect Social Security retirement benefits at some point, yet there is a lot about Social Security that isn't well-understood by many people.

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With that in mind, here are five important things you should know before you apply for your own retirement benefit that can help you make smarter decisions for you and your family.

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1. Know your full retirement age

You can decide to claim Social Security retirement benefits any time between ages 62 and 70, but your full retirement age is when you need to claim in order to get your full Social Security benefit. Depending on the year you were born, your full retirement age can be as early as 66 or as late as 67, so here's a guide that can help you find yours:

Year You Were Born

Full Retirement Age

1954 or earlier

66 years

1955

66 years, 2 months

1956

66 years, 4 months

1957

66 years, 6 months

1958

66 years, 8 months

1959

66 years, 10 months

1960 or later

67 years

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Source: Social Security Administration.

2. Know the effects of early or late Social Security

As I mentioned, you can claim Social Security as early as age 62, but your monthly benefit will be permanently reduced if you claim before your full retirement age. Specifically, for claiming early, your benefit will be reduced by these guidelines:

  • 5/9% reduction for every month (6 2/3% per year), up to 36 months before full retirement age.
  • 5/12% reduction for every month (5% per year) beyond 36 months, as early as age 62.

For example, let's say that your full retirement age is 67 and you decide to start collecting your retirement benefit at 63 (four years early). Your benefit will be permanently reduced by 25% -- 6 2/3% per year for each of the first three years before full retirement age, and 5% for the fourth.

On the other hand, if you choose to wait longer than your full retirement age, your benefit will be permanently increased at the rate of 8% per year (2/3% per month), as late as age 70. In other words, if your full retirement age is 67 and you wait until 70 to collect Social Security, your monthly checks would be 24% higher.

3. Know how much to expect each month

Full retirement age and the reduction/increase percentages are important to know, but the other piece of the puzzle is your benefit amount at full retirement age -- also known as your primary insurance amount, or PIA.

The formula used to calculate Social Security benefits is quite complex. Essentially, your lifetime annual earnings up to the Social Security taxable maximum are indexed for inflation, and the 35 highest annual totals are averaged together. This average is then divided by 12 and applied to a benefit formula to calculate your retirement benefit.

Fortunately, there's an easier way. If you haven't done so already, create an account at www.ssa.gov and view your most recent Social Security statement. Here you'll find a good estimate of your retirement benefit based on your work history, as well as how much you can expect if you retire at 62 or 70. It's also a good idea to check your lifetime earnings history for accuracy, as mistakes do happen, and missing earnings could result in a lower benefit than you're entitled to.

4. Know how Social Security benefits for spouses work

Social Security spousal benefits can be an important part of married couples' retirement strategies. Here's a more thorough look at how spousal benefits work, but in a nutshell, if one spouse's retirement benefit is more than twice the other spouse's, a spousal benefit kicks in to make the lower-earning spouse's retirement benefit at least half of the primary earner's.

For example, let's say that one spouse in a married couple is entitled to a benefit of $1,600 per month at full retirement age, and that the other spouse was a stay-at-home parent for most of his or her adult life, and is only entitled to a $300 monthly benefit on their own work record. In this case, a $500 monthly spousal benefit can be given to make the lower-earning spouse's benefit $800, or half of $1,600.

One important point is that while spousal benefits can be decreased for claiming before full retirement age, there is no boost for delayed retirement. In other words, a spousal benefit would be the same at age 67 as it would be at age 70. So it's generally not a smart strategy for couples who expect a spousal benefit to delay retirement past the lower earner's full retirement age.

5. Know if your Social Security benefits could be taxed

Depending on your total income, up to 85% of your Social Security benefits could be subject to federal income tax.

Whether or not your Social Security benefits are taxable depends on a number known as your combined income, which is your adjusted gross income (AGI) plus any nontaxable interest income and half of your Social Security benefits.

Here's a thorough explanation as well as a Social Security tax calculator, but generally speaking, if Social Security is your only source of income in retirement, you probably won't pay taxes on your benefits. However, if you earn significant income from a job, investments, or a business you own, there's a good chance you'll have to pay tax on at least part of your retirement benefits, so it's important to anticipate this before you apply for benefits.

The bottom line is that the more you know about your Social Security retirement benefits, the better-equipped you'll be to make wise retirement-planning decisions for you and your family. And knowing these five things before you apply for benefits is a smart way to get started.

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