Social Security may seem complicated, and there are certainly a myriad of rules to consider.
However, you don’t have to be a mathematician or economist to make the most of your Social Security benefits.
Let’s look at the answers to some of retirees' most critical Social Security questions.
How Do Social Security Benefits Work?
Social Security provides retirees with a consistent income stream once they retire and claim their benefits. In general, your Social Security income is estimated to replace about 40% of your pre-retirement income, but that number could vary significantly from person to person.
To qualify for Social Security benefits, you need to earn a minimum number of credits over your working years. You receive a credit by earning a certain amount of income from covered employment within a year. For 2021, you earn a credit for every $1,470 in income, up to 4 credits per year. To qualify for a retirement benefit, you need to earn 40 credits. For disability benefits, you need 20 credits.
Social Security benefits are funded through payroll taxes of 12.4%. If you are employed through a company, then your employer pays half of that amount for you. If you are self-employed, you pay the full 12.4%. You do get a little break come tax-time as you can deduct your half of the tax. Ultimately, you’ll only owe 12.4% on 92.35% of your income.
The amount of your income that is subject to the payroll (FICA) tax is capped by a limit set by the IRS each year. For 2021, that cap is $142,800.
Social Security benefits are one of the only types of retirement income that considers inflation. Each year, the Social Security Administration announces a cost-of-living adjustment (COLA). In 2021, benefits are set to increase by 1.3%. With the modest rise in Medicare premiums, beneficiaries will actually see an increase in their monthly checks.
Can You Calculate Your Benefit?
Qualifying for Social Security and determining the amount of your benefit are two different situations. In addition to ensuring that you earn enough credits to earn eligibility, you also need to track your benefit amount.
Social security benefits are based on lifetime earnings. The Social Security Administration calculates your benefits by indexing your highest 35 earning years against a formula to come up with your primary insurance amount. Your primary insurance amount is the value you’d get for claiming at your full retirement age—in other words, for filing “on time”.
Because your lifetime earnings directly affect the size of your Social Security benefit, we recommend that you check your earnings record often. If you do and notice a problem, you have time to correct it. You can check your earnings history on the Social Security website by creating an online account. You can also check out your local Social Security office for other questions or other benefit enrollment questions.
While it may seem like there isn’t much planning opportunity with your earnings record, there is a particularly key item we think you should pay attention to—your total number of earning years.
Work The Full 35 Years
Since Social Security benefits are calculated from your highest 35 years of earnings, it makes sense to make sure you at least have 35. If you don’t, say you only have 29 years, then the SSA inputs a 0 in their formula for every year under 35, in this case, 6.
Those zeros could have a significant impact on your monthly benefit. It’s often wise to work a few extra years to replace some of those zeros and boost your future benefit. If you are in your peak earning years, then those zeros could be replaced with above-average earnings. In the grand scheme of things, those extra earnings can make a big difference in your total Social security retirement benefit.
There is a maximum benefit depending on when you file, regardless of your earnings. For 2021, those maximums are:
Start at age 70 - $3,895/month ($46,740/year)
Start at FRA (full retirement age) - $3,113/month ($37,356/year)
Start at age 62 - $2,324/month ($27,888/year)
When Should You Enroll?
The decision of when to claim your benefit is perhaps the most debated question about Social Security. It may also be the most important. Your enrollment plays a major role in your future benefits.
If you claim at your full retirement age, you will receive your primary insurance amount as described above also known as your full benefits. However, you have two other choices. You can increase that benefit by accruing delayed retirement credits (up until you turn 70) or you can claim your benefit as early as 62 in exchange for a reduced benefit.
Claiming early can reduce your benefit by up to 30%, while delaying can increase it by up to 32%.
The common way of thinking about this decision is to consider when you would “break-even”. We tend to see that most clients that delay break even around the time they turn 78. After this, the clients that delay are better off for receiving the higher benefit.
By today’s standards, 78 is still quite young. However, like most financial planning decisions, this needs to be tailored to your circumstances. If you're planning an early retirement or have a medical condition or family history that suggests it is very unlikely you will live past 78, then it could be better to file early.
There are also special considerations for married couples. If you pass, then the benefit you leave to a surviving spouse depends on your own benefit, so it’s critical to consider how that decision affects them. There might also be other family members or dependents that rely on your income. Be sure to consider those circumstances as well.
Are Your Social Security Benefits Taxed?
Taxation is a key planning consideration in retirement. One of the reasons that Social Security benefits factor into your tax analysis is because they are taxed, and taxed uniquely. How will Social Security taxes factor into your benefit?
First, not all of your Social Security benefit is taxed. The amount of your benefit that is subject to income tax depends on a special measure of income called combined income. Your combined income is basically your gross income (not including Social Security) plus any tax-exempt interest such as the interest you receive from municipal bonds and one-half of your Social Security benefit.
Depending on your combined income, either none of your Social Security benefits is taxable, 50% is, or 85% is.
For individuals, the income thresholds for these taxation levels are:
Under $25,000 is 0%
$25,000-$34,000 is 50%
Over $34,000 is 85%
Some states also tax your Social Security benefits, but not all do. Fortunately, Virginia is a state that doesn’t!
How Does Working Impact Your Benefits?
Many people that claim their benefit early choose to continue working full-time or part-time. If you decide to start taking your benefit before you reach full retirement age and continue to work, then you may see your benefit temporarily reduced due to the earnings test.
There is a limit to how much you can earn while receiving Social Security benefits before your full retirement age. For 2021, that amount is $18,960. For every $2 you earn above that limit, your Social Security benefit is reduced by $1. However, in the calendar year you reach full retirement age, that earnings limit is increased to $50,520, and the reduction is reduced to $1 for every $3 you earn above the limit.
The bright side? You don’t lose this money for good. In addition to receiving your normal benefit amount, the amount you were penalized will be added back to your monthly benefit once you reach full retirement age.
Is Your Spouse Eligible?
Spousal benefits are the area where Social Security planning can become more complicated. It is especially helpful to work with an experienced financial advisor to evaluate the best options for you and your spouse.
Some of the available scenarios can be quite complex. For example, special rules allow a surviving widow/widower to receive a benefit as early as age 60 and continue to delay their personal benefit up to age 70.
Spouses are generally eligible to collect up to 50% of the primary earner’s benefit should they both collect at FRA. The lower-earning spouse should usually choose the higher of their own benefit or the spousal benefit of 50% of the primary wage earners benefit. A common misconception is that the spousal benefit reduces the primary earner’s benefit, but that is not the case.
Divorced spouses are also eligible for benefits provided they are at least 62, the marriage lasted 10 years, they haven't remarried (doesn't matter if the ex-spouse remarried or not), and the spousal benefit would be higher than their own.
You may have heard about a popular filing strategy called "File and suspend," which allowed the highest-earning spouse to delay their benefit while taking spousal benefits from their spouse to help maximize their total lifetime income from Social Security. Unfortunately, that has now been eliminated by Congress through the Bipartisan Budget Act of 2015.
Couples do, however, still have the option for the highest earner to delay until age 70, while other spouse takes their benefit. When the higher earner files and the spousal benefit is unlocked, the lower earner can then claim the higher spousal benefit.
Keep in mind that the lower-earning spouse would have to wait until their FRA to start their benefit to get the full spousal amount as well.
Let’s Make Social Security Simple Together.
There is much more to Social Security than deciding when to start your benefits. The rules can be complex and Social Security decisions need to be made in the context of a broader financial plan.
We can help you navigate Social Security with our training and experience. We also have access to software that helps us effectively analyze a client's Social Security scenario, and blend it in with their overall financial plan to help them make the best choices for their retirement.
Let’s discover how to maximize your Social Security benefits together. Talk to one of our financial advisors and get a free retirement assessment.
Scott is a Wealth Manager for Covenant Wealth Advisors and is a CERTIFIED FINANCIAL PLANNER™ (CFP©) practitioner and a Certified Public Accountant (CPA).
Scott has over 16 years of experience in the financial services industry in the areas of financial planning and investment management.
Covenant Wealth Advisors is a registered investment advisor with offices in Richmond and Williamsburg, VA. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital.
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