Written by: Tony Pitzer, CFP®, Partner, Wealth Manager
If you’re at the beginning or middle of your working career, you may not have given much thought to Social Security. If retirement is on the horizon, you may just be starting to wonder about the details. For a program that’s such a significant contributor to so many people’s later years, there are plenty of questions that commonly arise. Let’s take a look at the key things you need to know.
What is Social Security?
First, a little history. Social Security was created in 1935 to promote economic security during the Great Depression. Funded by contributions from the paychecks of people who were still working, it was designed to support retired workers who had reached the age of 65. Social Security also offers benefits to the disabled, as well as surviving spouses and minor children. As a retired person, you can depend on it for a stream of income payments over your lifetime—essentially the kind of benefit provided by an annuity you might purchase from a financial institution.
It’s important to note up front that Social Security never was intended to be your sole source of funds during retirement. For most people it replaces about 40% of working income. It can be a much lower percentage if you’re an exceptionally high earner, because there’s a maximum benefit amount as well as a limit on the amount of earned income that’s subject to Social Security tax. It’s expected that you’ll use other sources such as savings, investments, retirement accounts and pensions for supplementary retirement income.
When does Social Security eligibility begin?
When you work and pay Social Security taxes, you earn “credits” toward Social Security benefits. Eligibility to receive benefits requires 40 credits, which typically means 10 years of work. When to start taking Social Security is a decision with significant consequences. You have a number of options, and a variety of considerations make the choice a very personalized one.
You can start Social Security as early as age 62 (60 in some situations if you’re a widow or widower) or as late as 70. The age you start affects the amount you receive monthly. The baseline benefit is what you’ll get at “full retirement age,” which is age 66 for those born between 1943 and 1954, increasing gradually to 67 for those born between 1955 and 1960 or after.
If you start anytime between age 62 and your full retirement age, your benefits will be permanently reduced. Start anytime between full retirement age and 70, and the benefits you receive will increase by 8% per year until they begin. These changes are separate from the annual inflation adjustments that provide Social Security recipients with some protection against rising prices.
How do I decide when to start?
For those with little or no other income sources, beginning Social Security benefits at age 62 may be the only reasonable choice. It’s also possible to begin drawing benefits anytime between 62 and full retirement age while still earning income that’s subject to Social Security tax. If you do this, though, and earn more than an annually adjusted cap of $19,560 in 2022, $1 in benefits for every $2 earned over the cap will be deducted from each payment until you reach full retirement age. After that your benefit actually rises so over time you’ll recoup those reductions. Continuing to work after full retirement age has no effect on benefits.
Those with sufficient additional sources of income often are advised to delay benefits as long as possible, up till age 70. The rationale is that unless your other investments can reliably beat the 8% growth rate Social Security offers for waiting (not to mention the automatic inflation adjustment), it offers the better return. There is another factor to consider here too, though: longevity. If you delay benefits until age 70, you’ll need to live until age 83 to break even and enable the higher monthly benefits to make up for the years between full retirement age and 70 in which you received nothing. If you’re in good health and have a family history of long-lived ancestors, the odds are in your favor for waiting—also if your spouse is significantly younger than you and your benefit is the higher one they’ll continue to receive if you predecease them. If none of these situations apply, it may make more sense to begin benefits at full retirement age.
What should couples consider?
Another situation may involve two spouses who are close in age but have very different incomes. In this case it can be beneficial for the lower-earning spouse to begin benefits first while the higher-earning spouse delays and grows their benefit. If the higher-earning spouse passes away, it will be their benefit the surviving spouse receives.
A non-working spouse may be eligible to receive up to half of the working spouse’s full retirement age benefit. The non-working spouse cannot claim benefits until the working spouse has filed for benefits. If the non-working spouse claims benefits before their full retirement age then benefits will be reduced. However, the non-working spouse doesn’t get any credits for delaying benefits beyond their full retirement age.
And as we mentioned above, a widow or widower can begin collecting their spouse’s Social Security at age 60, and if they have a work history, they can continue to defer their own Social Security to age 70 if it has the potential to yield a higher benefit when they switch at a later date.
Also, if you’re divorced, your marriage lasted longer than 10 years, and you’re still unmarried at age 62 or older, you can claim spousal benefits even if you didn’t work enough to accrue sufficient Social Security credits.
How much will my Social Security benefits be?
Because Social Security stopped mailing paper statements to those younger than 60, most people don’t have a good idea of what their future benefits actually are. But as you’ll see at the end of this blog, it’s easy to go online, establish an account with Social Security, and view or download updated statements that include current projections of your benefits whenever you like. The formula Social Security uses to calculate benefits is complicated, but essentially it involves applying a percentage factor to the average of your highest 35 years of earnings. You can get a rough idea of your benefit by using the Social Security calculator on the Merit Financial Advisors website.
According to Social Security’s regularly updated figures, the average benefit as of July, 2022 is $1,624.98. The maximum benefit you can receive in 2022 at full retirement age is $3,345, which is reduced to $2,364 if you claim your benefit at age 62. And of course delaying past full retirement age gets you that 8% annual increase along with inflation adjustments—which for those turning 70 this year adds up to a maximum of $4,194.
Is Social Security taxable?
The amount of your Social Security benefit that’s taxable depends on your total income and may be either 0%, 50% or 85%. Most people find that 85% of their benefit is subject to tax. If you’re married and filing a joint return and your income is below $32,000 a year (or $25,000 for an individual return), there’s no tax on your benefit. For income between $32,000 and $44,000 ($25,000 and $34,000 for individual returns), half your benefit is taxable. And once you’re over $44,000 ($34,000 for individual returns), 85% of the benefit is taxable.
Is Social Security guaranteed?
Social Security is a “pay-it-forward” system. This means the taxes deducted from the earnings of people who currently are working support the benefit payments going to those who now are retired. Given the mass dynamics and shifting age of the U.S. population, there’s a point in time around 2035 when, if there are no changes to Social Security, it won’t be able to pay out its full benefit. Right now projections indicate it would only be able to pay out 76% of scheduled benefits. So if someone were scheduled to receive $1,000 a month, they’d only get $760 in this worst-case scenario. The timeline for this situation changes a bit every year, but continues to be somewhere in the mid-2030s.
Social Security has been in jeopardy before, though. One of the biggest changes was in 1983, when the Reagan Administration adjusted the retirement age and made other changes that helped keep the program funded longer. The Obama Administration also made some changes a while back to eliminate certain claiming strategies and extend benefits. It’s likely that Congress will make further adjustments in the years ahead so you can plan on Social Security being there for you as expected. Your determination of when it’s best to begin claiming shouldn’t be based on speculating about whether Social Security will be able to pay full benefits. Your health outlook and income situation are more important factors.
Take a closer look at your benefits today
If you haven’t registered for an online account with Social Security, it’s never too early to do so. Just visit their website and follow a few simple steps to verify your identity and establish your login credentials. From then on, you’ll be able to keep an eye on the income that’s credited to your account every year and see up-to-date projections of what your benefit will be, depending on when you start taking it. Use your online access to check that your account reflects the correct amounts you’ve earned over the years. Sometimes name changes, job changes, or clerical errors can result in less income being credited than you deserve—and that will lower your ultimate benefit. Using your account to apply online also can be a lot easier than trying to get an in-person appointment at your local Social Security office when it’s time to start receiving benefits.
If it seems like there are a lot of things to consider when choosing the best Social Security strategy for you, you’re right. An advisor or a CERTIFIED FINANCIAL PLANNER™ here at Merit can provide invaluable help in navigating through it all. We have access to specialized tools, such as a Social Security Optimizer that lets us input your projected benefits, retirement date, marital status and estimated life expectancy, then explore how outcomes vary depending on when you start your benefits. There’s no better way to make an informed decision about maximizing the value of one of the primary pillars of the typical retirement plan.
For assistance with the complexities of Social Security, or professional advice on investing, estate planning and other aspects of a comprehensive financial plan tailored to your goals, reach out to one of our advisors to discuss how they can help. Contact Merit Financial Advisors today!