We have all heard someone say that saving and investing are necessary for an effective retirement plan. What we don’t here enough about is another important element of retirement your plan: Social Security planning.
The importance of implementing Social Security planning into retirement planning cannot be understated. Several studies show, people aren’t saving or investing enough for a meaningful retirement. Social Security income prevents 4 out of 10 people age 65 and older from living on incomes below the poverty line. This group of seniors depend on Social Security for about one-third of their income on average.
Many do not understand how Social Security works.
If you’re getting close to retirement, you should be investigating your options: In other words do I claim my benefits when I turn 62, or wait as long as possible?
Many of our young aged in their 20s or 30s, wonder whether Social Security will spend its way out of existence before their eligible to draw any money from the fund.
I will now discuss how Social Security works and put some minds at ease about whether Social Security will be around for you when it’s your turn to draw it.
Social Security exist as much more than simply a retirement program. This fund is setup to help people who are disabled, the survivors of workers who have died, and the dependents of recipients.
Due to the fact that retirees exist as the largest group of people to receive benefits, This segment deals primarily with Social Security retirement benefits.
1. How Are Social Security Benefits Calculated?
Our Social Security benefits is based on three primary elements: our work history, our 35 highest-earning years and our age when we elect to begin receiving benefits. Cost of living adjustments, COLAs, may be considered another element, but that elements impact on Social Security is very small.
Your work history explained: You acquire one Social Security credit for every $1,410 you earn in 2020, but you are limited to four credits a year no matter how much you earn. When you acquire 40 credits, you become eligible for benefits you are able to collect when you reach retirement age. In other word after 10 years or 40 quarters of working full-time, you’re deemed “fully insured” for retirement benefits.
Your 35 highest-earning years: Social Security calculates your benefits depending on the 35 years you made the most money and yes there is a limit, which is $137,700 as of 2020. For those who make $1 million, even $1 billion in 2020? With respect to Social Security’s, it’s the same as earning $137,700. The reason for this rule is simply any money you legally make above $137,700 isn’t subject to Social Security taxes.
For those who work less than 35 years, the government will still base your benefits on 35 years of earnings, however, the government will use $0 for your non-working years.
For example, let’s say you begin working at 18 and retired at 52, the government will use your 30 years of wages plus five years of $0. Those zeroes will have a significant impact on your monthly benefits when you retire early or if you take a break from the workforce for a long stretch.
Also, your earnings are adjusted for inflation to calculate what Social Security calls your Average Indexed Monthly Earnings (AIME).
When you claim benefits: Your AIME is used to calculate your monthly benefit when you reach full retirement age, which is the age at which you qualify for full benefits. The age is 67 for anyone born in 1960 or later and approximately 66 years for many people born earlier.
Most people are eligible to claim benefits at age 62 — at a reduced amount. Most people have the option to wait and claim their benefits when they reach age 70 in exchange for larger monthly checks.
If you take benefits early: When choosing this option Social Security checks are reduced by five-ninths of 1% for every month you start receiving benefits before your full retirement age. That adds up to a 6.66% lifetime reduction in monthly benefits for every year of early benefits.
If you wait until you’re past your full retirement age to claim: Upon reaching full retirement age, Social Security grants you an extra 8% for every year you hold off until you reach age 70, at age 70 benefits max out.
The benefit of deferring until age 70: a monthly benefit that’s 76% higher contrasted to if you’d started receiving at 62, according to the Social Security Administration.
Make a habit of: Using one of the Social Security Administration’s benefit calculators at SSA.gov to estimate how much you’ll be eligible for upon reaching retirement.
COLAs: Social Security recipients receive cost-of-living adjustments based on inflation. COLAs announcements go out in October for the following year.
Normally, COLA adjustments are fairly minimal: Over the last 10 years, COLA ranged from 0% to 3.6%. In 2020, beneficiaries received an extra 1.6%. A similar COLA is anticipated for 2021.
2. Are You Allowed to Take Benefits Based on Your Spouse’s Record?
Yes. Most people may collect benefits based on the work record of their current spouse, a deceased spouse and yes an ex-spouse as well in some cases. Just remember, you are not allowed to claim for both yourself and a current or former spouse. Always… decide whether you’ll get more based on their work record or your own.
You are allowed to collect on your current spouse’s record if:
You’ve been married for at least a year.
Your spouse is already taking their benefits.
You’re at least 62, or you’re caring for a child who’s under 16 or disabled.
Benefit amount: 32.5% to 50% of your spouse’s benefit.
You are allowed to collect on the record of a spouse who died if:
You’re a minimum age of 60 or you’re minimum age 50 and disabled. You may also qualify if you’re caring for the deceased spouse’s child.
You were married for at least nine months, unless the death was accidental or occured in the line of military duty.
You didn’t remarry before age 60, or age 50 if you’re disabled. If you remarry later, you may still collect on your late spouse’s record.
Benefit amount: 71.5% to 100% of your late spouse’s benefit.
You are allowed to collect on your ex-spouse’s record if:
You were married for at least 10 years and haven’t remarried.
You’ve been divorced for at least two years.
You’re at least 62.
Your former spouse remains eligible for benefits, though you can still claim based on their record even if they haven’t started taking benefits yet.
Benefit amount: 50% of your ex-spouse’s benefit.
Remember… when you’re claiming on the record of a spouse you’re divorced from, their monthly benefits won’t be reduced as a result. Remember…, if they’ve been married multiple times, there’s no need to fight with the other exes you are all allowed to go to the Social Security office. You are all allowed to claim based on their record if you choose.
3. What’s the Average Monthly Social Security Benefit?
The average monthly benefit for retired workers was $1,514 as of June 2020. The maximum benefit for someone who retires at age 62 in 2020 is $2,265. But a worker who waited until 70 to retire may receive up to $3,790 per month.
As stated earlier, only the highest-earning workers will qualify for maximum benefits.
4. Is Social Security Enough to Retire on?
Social Security replaces approximately 40% of pre-retirement income for the average worker —financial planners normally suggest replacing about 70% to 80% of pre-retirement income. In other words it’s critical that you save for retirement by contributing to a 401(k) plan or funding a Roth IRA or traditional IRA.
Social Security was never intended to be the sole source of income for retirees, and this fact and not planning for retirement cause many older Americans to struggle financially. Approximately 50% of seniors depend on Social Security for approximately 50% of their income and approximately 25% depend on it for 90% or more, according to the Center on Budget and Policy Priorities.
5. Who Pays for Social Security?
Most of us, law abiding taxpaying citizens. As well as your employer.
Social Security is funded by payroll taxes, you may remember seeing it listed on your earnings statement as FICA taxes.
Normally workers contribute 7.65% of their paychecks automatically deducted for FICA taxes. Your earnings are taxed at 6.2% for the first $137,700 of earnings as of 2020. Anything you earn above that isn’t taxed for Social Security — which is why $137,700 is the maximum amount considered for calculating your benefits.
The remaining 1.45% goes toward Medicare, the difference is here there’s no salary maximum. Remember, individuals that earn more than $200,000 and married couples that earn more than $250,000 are taxed an extra 0.9% Medicare tax.
Employers matche your 7.65% contribution toward Social Security and Medicare. In other words self-employed workers pay 15.3% because they are required to pay both the employee and employer contributions.
6. Is It True That Social Security Is Going Broke?
Don’t believe the hype.
It is true that Social Security is changing. Beginning in 2021, it will take in less money than it pays out, because of longer life expectancies and people having fewer children —fewer workers are paying into the system.
Social Security has a $2.9 trillion trust fund, these funds are estimated to be gone by 2035 if nothing changes. Remember, in America things always change and the program has survived bad times before. Social Security is funded on a pay-as-you-go basis.
This means the fund is always losing money as a trust fund, remember, the good news is….it continues collecting payroll taxes from workers and employers. If the trust runs dry in 2035, payroll taxes will generate enough to pay for approximately 79% of the program’s obligations even if Congress does not take any action.
Also, there are several actions Congress could take to avoid Social Security cuts. For example, it could increase the tax rate, eliminate the wage cap or raise the full retirement age, similar to actions taken in 1983.
The most likely scenario is that Congress will take action. A 2019 Pew Research Center poll found that 74% of Americans oppose cutting benefits. Lawmakers on both sides of the aisle pay close attention to the program’s popularity among voters.
Let’s discuss President Trump’s 2020 payroll tax holiday. We know that Congress didn’t approve the tax cut, therefore, workers who are enjoying an additional 6.2% in their paychecks can plan on owing payroll taxes in 2021. This makes the impact on Social Security funds very small.
Worst case Congress approves the tax break retroactively, Congress will most likely replenish Social Security fund using general funds, as they did in 2011 and 2012 when President Obama cut payroll taxes.
7. Can You Work and Claim Social Security Benefits?
If you’ve already reached full retirement age, feel free to work away if you choose. Your benefits won’t be affected no matter how much you earn.
A word of caution… if you collect Social Security early, your benefits will be decreased by $1 for every $2 you earn above $18,240 in 2020. You receive more flexibility during the year you reach full retirement age: You’ll have $1 withheld for every $3 you earn above $48,600, and then once you actually reach that age, your benefits will no longer be reduced.
8. Are Social Security Benefits Taxed?
If you receive additional income, from a job or investments, normally part of your Social Security will be taxed. Here’s how that works.
If you’re a single filer:
0% of your benefit is taxable if your income is below $25,000.
Up to 50% of your benefit is taxable if your income is between $25,000 and $34,000.
Up to 85% of your benefit is taxable if your income is above $34,000.
If you’re married filing jointly:
0% of your benefit is taxable if your combined incomes are below $32,000.
50% of your benefit is taxable if your combined incomes are between $32,000 and $44,000.
85% of your benefit is taxable if your combined incomes are above $44,000.
Remember, “taxable” doesn’t mean that’s what you pay in tax. Suppose you’re a single filer with $30,000 of income: $20,000 from Social Security benefits and $10,000 from 401(k) withdrawals.
That means that your income will be $20,000 in the eyes of the IRS: $10,000 from the 401(k), plus 50% of the $20,000 from your Social Security benefits. The government is not allowed to take from the remaining 50%.
Remember, if you’re still working and saving for your retirement, there is a great benefit from having a Roth IRA or Roth 401(k). When using the tax break during your working years, you earn a tax-free income in your retirement years — this income does not count against you for Social Security purposes.
In the previous example, if the $10,000 of 401(k) income had come from a Roth IRA instead, your income would be $0 in the eyes of the IRS. The $10,000 is not allowed to be counted against you, in other words you’d fall below the $25,000 income threshold. That results in 0% of your Social Security benefit being eligible for taxs.
If Social Security is the only source of income, you normally will not be taxed on it, because the average benefit amounts to $18,168 per year.
9. What’s the Best Age to Collect Social Security?
The decision on when to start collecting Social Security is a personal choice. The fact is, many people don’t have the option to delay benefits because they’re forced to retire early due to their health status, a job loss or the requirement to care for a spouse, child, or parent.
For those positioned to do so, and those that desire larger monthly checks, it makes more financial sense to wait as long as possible. For those who desire more checks over the course of their lifetime and accept the fact that the checks will remain smaller, by all means collect your Social Security earlier.
For those who experience medical issues or your parents passed away relatively young, these situations may warrant collecting benefits earlier. It is recommended that those who are healthy wait as long as possible, considering you have the potential to outlive your money.
Another strategy for married couples is to try to maximize their benefits by having the higher earner wait as long as possible while the lower earner claims at 62. Once the higher-earning spouse starts collecting, the lower earner switches over from their benefit and starts collecting half of the higher earner’s benefit.
10. Can You Get Social Security if You Haven’t Worked?
You may still receive Social Security retirement benefits based on a current, former or deceased spouse’s record even if you’ve never worked. Outside of this condition, you are required to pay into the system to collect benefits.
Children of a deceased worker qualifies for survivors benefits until they’re 18 or 19 if they’re still enrolled in high school full time. If the child is over 18 but has a disability that began before age 22, they may also qualify for survivors benefits.
11. How Do You Apply for Social Security?
The process is simple apply for Social Security online in approximately 15 minutes. Local Social Security offices remain closed due to COVID-19 since March, for answers to questions, you are encouraged to dial 800-772-1213 between 8 a.m. and 7 p.m. Monday through Friday.
12. Can You Reverse Your Decision to Start Benefits?
Yes, just remember your options for reversing your Social Security decision are extremely limited: If it’s been less than a year since you started benefits, you may withdraw your application and repay all your benefits, including Medicare premiums, taxes you decided to withhold and benefits your family received on your behalf.
If you’ve reached full retirement age, you may suspend your benefits allowing you to take advantage of the extra 8% Social Security gives you for every year you delay beyond your full retirement age. Once you hit 70, your benefits will automatically restart.
Robin Hartill is a certified financial planner and a senior editor at The Penny Hoarder. She writes the Dear Penny personal finance advice column. Send your tricky money questions to DearPenny@thepennyhoarder.com.