The topic of Social Security is complex. Misinformation about how it works or what is available causes many to miss out on critical benefits. Plus, a lack of knowledge about Social Security can hinder retirement planning efforts. Preventing some from maximizing their income in their later years. By understanding how Social Security functions and the role it can play in retirement, you can make the most of what it offers. With that in mind. Here’s what you need to know now about Social Security.
Social Security Isn’t Disappearing Soon
Many fear that Social Security isn’t going to be around by the time they would be eligible for benefits. While the program has had financial challenges, it isn’t necessarily doomed to disappear.
For many decades, Social Security collected more than it had to pay out. This created a surplus of nearly $2.9 trillion. While Social Security is now dipping into that reserve, if nothing about the program changes, it could still last until 2034.
Even if the reserve disappears, it won’t bankrupt Social Security. Instead, the amount people receive in benefits may have to go down. It’s possible that people will only receive 79 percent of what they expect.
However, if funding changes are made, the situation could improve. While Social Security reform is typically a contentious topic, it’s possible that agreements will be made to keep the program running.
Other Sources of Income Are Necessary
Social Security isn’t meant to be a person’s sole source of retirement income. Instead, on average, it is designed to cover about 40 percent of an individual’s preretirement wages.
While some do rely on Social Security alone, they usually experience significant financial hardships. As a result, it’s best to maximize your Social Security benefits but also supplement it with other income, such as funds from a 401(k) or IRA.
Delaying Your Benefits is Usually Wise
Depending on when you were born, you can access your full Social Security retirement benefits between the ages of 66 and 67. However, you can technically take early retirement, allowing you to receive money as early as age 62.
Some people may think that taking your benefits early is a good idea. But, if you do, your benefit shrinks. By retiring as soon as possible, the reduction can be as high as 25 to 30 percent, depending on your birth year. And, once a reduction is in effect, it stays that way. Essentially, it’s permanent unless you repay your Social Security benefits and select a new start date, something that many retirees can’t afford.
As you get closer to full retirement age (while still being considered in early retirement), the size of the reduction shrinks. However, it can be significant, even if you only retire one year before full retirement age.
On the other side of the equation, drawing Social Security late increases your benefit. You can receive an 8 percent increase each year you wait. For example, for those who qualify for full retirement at age 67 and wait until age 70, your benefit goes up by 24 percent. That’s a pretty big bonus for delaying.
But Don’t Delay Past Age 70
Once you reach age 70, you don’t get a benefit increase for waiting any longer. While you technically aren’t required to file for your benefits, it doesn’t do you any good to delay. All it means is missing out on money that could become part of your income.
There is a Maximum Benefit
Social Security does have a maximum benefit size. Once you reach it, your benefit doesn’t go up regardless of what you do.
In 2020, the maximum benefit for those reaching full retirement age is $3,011. If you wait until age 70, the maximum benefit goes up to $3,790, while those who retire at 62 can receive no more than $2,265.
Working While Collecting Social Security
There’s a lot of misinformation about the impact of continuing to earn an income while collecting Social Security benefits. It’s true that your benefits may be reduced. Typically, the reduction is $1 for every $2 you earn as income after crossing a specific threshold (which is set at $18,240 for 2020) until you reach full retirement.
Then, it’s $1 for every $3 earned beyond a new threshold (which is set at $48,600 in 2020). However, after that point, you can make as much as you want without any additional reductions.
While it may seem like you’re missing out on some benefits by working, that isn’t the case. Technically, you are deferring income payments, not forgoing them entirely. You’ll receive the money as a credit once you reach full retirement age, so you do get it back, essentially.
What Social Security Payments Are Based on
Social Security benefit calculations are a bit complex. However, one important factor in determining them is how much you earn while you’re working.
Your benefit is based on your 35 highest-earning years, even if they aren’t consecutive. That means one low-earning year in the middle of your career won’t harm your benefit if you had another higher-earning year during another period.
However, if you don’t have 35 income-earning years, any missing years are calculated at $0. For example, if you only worked for 30 years, you’ll have five $0 years in the calculation. But, if you work any as you approach retirement, including just part-time, you can replace those $0 years with other values.
Spouse’s Benefits Might Be a Better Deal
If you’re married when you claim Social Security, you might be able to replace your benefit with a spouse’s benefit and bring in more income. This program allows one spouse to receive up to 50 percent of their spouse’s benefit in lieu of their own, which might work in your favor.
For example, if one spouse receives $2,200 in Social Security each month and the other only gets $500 monthly, switching to the spouse’s benefit could let the latter spouse receive $1,100 every month instead. That’s $600 more.
Getting the most from a spouse’s benefit is contingent on waiting until full retirement age. If you file for Social Security early, it is reduced. Additionally, the higher-earning spouse has to file for Social Security before the spousal benefit is available. However, if that person retires later, it is possible to switch to the spousal benefit at that point.
Social Security Isn’t Always Tax-Free
Many people assume that Social Security income isn’t taxable. However, that isn’t necessarily true. If your total household income crosses certain lines, you may have to pay taxes on up to 85 percent of your Social Security benefits.
In 2019, married couples filing jointly that had a combined income of $32,000 to $44,000 had to pay taxes on up to 50 percent of the Social Security income benefits. If the combined income (adjusted gross income) was over $44,000, then up to 85 percent of the benefit was taxable.
Social Security Adjusts for Inflation
Every year, the Social Security Administration (SSA) examines the Consumer Price Index to see if it needs to adjust the benefits to account for inflation. If so, SSA issues a Cost of Living Adjustment (COLA) to ensure that the benefits are appropriate.
While COLA is a possibility every year, it doesn’t always happen. If there is no inflation, there won’t be a benefits increase. While it’s somewhat rare, it has happened three times since 1975. 2009, 2010, and 2015 all didn’t have COLA increases. Plus, the COLA bump in 2016 was only 0.3 percent, which is incredibly small.
However, some have been substantial. In 2011, the COLA increase was 3.6 percent. For 2018, it was 2.8 percent. There are even two double-digit years, though those were in the early 1980s (1980 and 1981, to be exact).
There is a Problem with the COLA Formula
While COLA is supposed to protect retirees from the effects of inflation, there is an issue with the formula. It doesn’t account for the rising cost of medical care, an expense that is often a major part of a retiree’s budget. As a result, Social Security’s purchasing power is falling.
Are you worried about your Social Security benefits? Do you include Social Security in your retirement planning? Share your thoughts in the comments below.
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Tamila McDonald has worked as a Financial Advisor for the military for past 13 years. She has taught Personal Financial classes on every subject from credit, to life insurance, as well as all other aspects of financial management. Mrs. McDonald is an AFCPE Accredited Financial Counselor and has helped her clients to meet their short-term and long-term financial goals.