In this series, we have looked at some important topics regarding retirement planning. We have focused on saving for retirement, looking at how much you should save, how you can jumpstart your savings, and how your retirement age affects your retirement income. In the previous article, we looked at the various retirement accounts you can use to grow your saving.
In this article, we want to take a brief pause to look at another source of income during retirement – social security benefits. The goal is to help you understand how social security works and the impacts it will have on your retirement planning.
What is Social Security?
Franklin Roosevelt passed The Social Security Act (SSA) into law on August 14, 1935. The law began to take effect in 1940 when the first check was issued to a retired legal secretary. Social security is an old age, survivors, and disability insurance (OSDI) program. Social security has two different funds – the OASI trust fund for the retirees and the DI trust fund for disability beneficiaries.
Payments towards retirement benefits are managed through the OASI trust find. Workers pay into the program through payroll withholdings. Every time a worker pays into the fund, he or she earns a credit. Each worker can earn up to four credits per year.
Who Qualifies for Retirement Benefits?
To qualify for retirement benefits from social security, the retired worker must have accumulated 40 credits over ten years.
The worker who has made these payments over ten years can begin to tap into social security benefits at the age of 62. However, the worker doesn’t need to start enjoying the benefits at 62. A worker can decide to postpone the receipt of benefits from social security. Postponement of benefits is beneficial up to age 70.
For married couples, a spouse can decide to claim benefits on the earnings record of the other partner if the latter has higher earning years. The spouse will get 50% of the other partner’s payment. Therefore, the spouse will need to be sure that 50% of the other partner’s payment is higher than what he or she will get if they do the calculations on their earnings.
In the case of divorce, a divorced spouse can receive benefits based on the earnings record of the other partner if the marriage lasted at least ten years, and the divorced spouse has not remarried.
How the SSA calculates Social Security benefits
The social security benefit is calculated based on the average indexed monthly earnings of the worker over the 35 highest-earning years. If a worker spent more than 35 years in the workforce, the calculations would be based on the 35 years he or she earned the highest income. The other years are disregarded. If years of service do not equal 35 years (let’s say 24 years), the benefits are calculated based on the available years (24 years) while every year it takes to get to 35 years of service ((the remaining 11 years) is counted as zero. The effect of this is that the worker who spent less than 35 years will get lower benefits.
The initial payment you will get from social security is calculated thus:
- 90% of the first $960 of the average indexed monthly earnings
- 32% of the remaining earnings up to $5785
- 15% of the earnings above $5785
The calculation above is a base figure. Actual payment will depend on the age you start claiming benefits and any deduction for Medicare premiums.
Social Security and Retirement Age
Social security benefits vary depending on when you start making claims. You can start claiming benefits by age 62. However, if you delay your claims until the full retirement – age 66 if you were born in 1954, additional two months for every year after 1954, age 67 if you were born in 1960 – you will qualify for higher benefits. Also, if you delay payments until age 70, you will get higher payments. However, after age 70, there is no benefit to delaying the claim for social security benefits.
The average benefit for someone retiring at age 66 is $1503 per month or $18,036 per year. The maximum payment is $3011 per month. According to the SSA, claiming benefits at 62 can reduce the monthly payment by 30% while claiming it at 70 can increase the monthly payment by 32%.
To get a good grasp of how much you can expect depending on when you retire, use the retirement estimator on the SSA website.
Social Security and Taxation
If all the earnings of a retiree come from social security, they are tax-free. However, if he or she also has earnings from a pension, part-time work, retirement accounts, etc., the earnings will be subject to income tax.
If the sum of income in retirement is less than $25,000 (single filing) or $32,000 (joint filing), there is no tax on the social security benefits. If the income is between $25,000 and $34,000 (single filing) or $32,000 and $44,000 (joint filing), 50% of the social security benefits are taxable income. Also, if the income is above $34,000 (single filing) or $44,000 (joint filing), 85% of social security benefits are taxable income.
While the primary focus in retirement planning should be retirement savings in a retirement account, it is also essential to understand the place of social security. The two significant decisions here is when to start making a claim and whether to use your earnings record or your spouse’s. It’s also important you consider the different ways you can reduce your tax liability.