Social Security is millions of retirees' primary source of retirement income, but a lot of people seem to know surprisingly little about it. This is a problem -- if you don't understand how the program works, you could make a mistake that costs you thousands of dollars in benefits. Or you may overestimate how much you'll receive and underestimate how much you need to personally save for retirement. But you can avoid these mistakes by understanding the following five key facts about your Social Security benefit.
1. It was only ever designed to replace about 40% of your pre-retirement earnings.
While many retirees consider Social Security their main source of income, the program was never designed that way. It was only ever intended to replace about 40% of pre-retirement income for average earners according to the Social Security Administration (SSA), though it doesn't define what "average earner" means -- it may cover a little more than this for low-income households, or less for high earners.
2. It's based on your average monthly earnings during your 35 highest-earning years.
The SSA calculates your benefit by taking your total taxable income for each year of your employment and multiplying that number by the index factor for that year, which can be found in this worksheet. Then it takes the 35 years with the highest indexed earnings, totals them up, and divides by 35 and then by 12 to get your average indexed monthly earnings (AIME). Then you calculate your benefit at your full retirement age (more on that below) using the appropriate formula. For those who first become eligible for Social Security in 2019, the following formula applies:
- Multiply the first $926 by 90%.
- Multiply any amount over $926 but under $5,583 by 32%.
- Multiply any amount over $5,583 by 15%.
- Add the three numbers above and round down to the nearest dollar.
If you've worked less than 35 years the SSA will include zeros in your calculation, and this will bring down the average considerably, so it's best to work for at least this long, and longer if you can. That way your lower-earning years will drop off and get replaced by higher-earning years, bringing up your AIME. Whatever you do, work at least 10 years; otherwise you won't qualify for Social Security at all.
3. It depends on the age you begin claiming it.
The calculation listed above determines your benefit at your full retirement age (FRA). This is 66 or 67, depending on your birth year. You can begin benefits earlier than this, but then you'll receive a reduced amount per check to account for the extra months you're receiving benefits. If you begin as soon as you're eligible at 62, you'll only receive 70% of your scheduled benefit per check if your FRA is 67, or 75% if your FRA is 66.
Your checks increase for every month that you delay benefits past your 62nd birthday until you hit your full scheduled benefit at FRA. You can continue delaying benefits and your checks will keep increasing until you reach the maximum benefit at 70. This is 124% of your scheduled benefit if your FRA is 67, or 132% if your FRA is 66.
4. It may be taxable.
The federal government can tax your Social Security benefits if your combined income is over certain limits. Combined income is defined as your adjusted gross income (AGI) -- income minus tax deductions -- plus any nontaxable interest and half of your Social Security benefits.
If you file taxes as an individual and your combined income exceeds $25,000, the government may tax up to 50% of your benefits. The same goes for married couples filing jointly with a combined income greater than $32,000. Individuals with a combined income exceeding $34,000 and married couples filing jointly with a combined income greater than $44,000 may owe taxes on up to 85% of their Social Security benefits.
But just because the government can tax you up to those limits doesn't mean it will. There's a complicated formula that determines how Social Security benefits are taxed, and it's beyond the scope of this article. Here's a detailed overview for those interested in learning more about Social Security benefit tax.
5. It probably won't go as far in the future.
You may have heard that Social Security won't be around for future generations of workers, but this isn't true. While its trust funds are expected to be depleted by 2034 unless the government makes some changes to the program, it isn't going to disappear -- even if the program stayed exactly the same, it would still be able to pay out 79% of promised benefits until 2090.
Possible Social Security fixes include raising the full retirement age, reducing benefits, raising the ceiling on income subject to Social Security tax (currently $132,900 in 2019), and reducing the cost-of-living-adjustments (COLAs) that help Social Security keep pace with inflation. We don't know what solution or combination of solutions will eventually win the most support, but it's possible that Social Security checks won't go as far in the future as they do today. That's why it's crucial to prioritize saving for retirement on your own.
Social Security is a guaranteed source of income in retirement, but it's easy to make a mistake that costs you benefits. By understanding these five things you can take steps today to maximize your Social Security benefits and personal savings so you can have a comfortable retirement.
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