How Does Social Security Work? 12 Things You Can’t Afford Not to Know

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You probably know that saving and investing are essential to retirement planning. But just as important to the equation: Social Security planning.

It’s impossible to overstate the importance of Social Security to retirees. The truth is, Americans aren’t saving or investing enough for a secure retirement. Without Social Security, approximately 4 out of 10 people age 65 and older would have incomes below the poverty line. That same group relies on Social Security for about one-third of their income on average.

But there’s a lot of confusion surrounding Social Security.

If you’re approaching retirement, you’re probably doing the math: Should you claim your benefits the second you turn 62, or wait as long as possible?

And if you’re in your 20s or 30s, you may worry whether Social Security will spend its way out of existence long before you get a cent.

Here’s a guide to how Social Security works — and why no matter how old you are, you don’t have to worry about whether it will be around for you.

How Does Social Security Work? 12 Questions Answered

Social Security isn’t just a retirement program. It also provides for people who are disabled, the survivors of workers who have died and the dependents of recipients.

However, because retirees are by far the largest group of people to receive benefits, we’re focusing on Social Security retirement benefits in this article.

1.How Are Social Security Benefits Calculated?

Your Social Security benefits depend on three primary factors: your work history, your 35 highest-earning years and your age when you start receiving benefits. Cost of living adjustments, or COLAs, are another factor, but their impact is relatively minimal.

Your work history: You earn one Social Security credit for every $1,640 you earn in 2023, but you can’t earn more than four credits a year. As long as you earn $6,560 in 2023, you’ll receive the maximum of four credits for the year. Once you’ve earned 40 credits, you’ll be eligible for benefits once you’re retirement age. That means that after 10 years of working full time, you’re considered “fully insured” for retirement benefits.

Your 35 highest-earning years: Social Security calculates your benefits based on the 35 years you earned the most money — but only up to a limit, which is $160,200 in 2023. (That’s up from $147,000 in 2022.) If you earn $1 million, even $1 billion in 2022? For Social Security’s purposes, it’s the same as earning $160,200. That’s because any money you earn above $160,200 isn’t subject to Social Security taxes, which we’ll get to shortly.

If you work less than 35 years, they’ll still base your benefits on 35 years of earnings, but they’ll use $0 for your non-working years.

So if you started working at 20 and retired at 50, they’d use your 30 years of wages plus five years of $0. Those zeroes could seriously drag down your monthly benefits if you retire early or were out of the workforce for a long stretch.

Then, your wages 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. It’s 67 for anyone born in 1960 or later and 66 years and change for most people born earlier.

You can take benefits as early as 62 — but you’ll receive a reduced amount. Or you can delay until you’re age 70 in exchange for bigger monthly checks.

  • If you take benefits early: Your Social Security checks are reduced by five-ninths of 1% for every month you start getting 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: Once you reach full retirement age, Social Security thanks you with an extra 8% for every year you hold off until you reach age 70, when benefits cap out.

The reward for waiting until 70: a monthly benefit that’s 76% higher compared to if you’d started claiming at 62, according to the Social Security Administration.

COLAs: Social Security recipients receive cost-of-living adjustments based on inflation. COLAs are announced in October for the following year.

For 2023, the COLA was a record 8.7%, the largest Social Security raise in four decades. This year’s COLA gave the average retirement check a $147 monthly boost and added $119 to the average monthly disability check.

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2. Can You Take Benefits Based on Your Spouse’s Record?

Yes. You can collect benefits based on the work record of your current spouse, a deceased spouse and even an ex-spouse in some cases. However, you can’t claim for both yourself and a current or former spouse. You have to decide whether you’ll get more based on their work record or your own.

You can 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 can collect on the record of a spouse who died if:

  • You’re at least 60 or you’re age 50 and disabled. You can 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 occurred 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 can still collect on your late spouse’s record.

Benefit amount: 71.5% to 100% of your late spouse’s benefit.

You can 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 is eligible for benefits, though you can still claim based on their record even if they haven’t started taking benefits yet.

Benefit amount: 32.5% to 50% of your ex-spouse’s benefit.

Note that if you’re claiming on the record of a spouse you’re divorced from, their monthly benefits won’t be reduced as a result. Also, if they’ve been married multiple times, there’s no need to race the other exes to the Social Security office. You can all claim based on their record if you choose.

3. What’s the Average Monthly Social Security Benefit?

The average Social Security benefit is $1,827 per month in January 2023. The maximum possible Social Security benefit for someone who retires at full retirement age is $3,627 in 2023. Someone who waits until age 70 can receive up to $4,555 per month.

Remember, of course, that only the highest-earning workers will qualify for maximum benefits.

4. Is Social Security Enough to Retire on?

Social Security will replace about 40% of pre-retirement income for an average earner — and financial planners usually recommend replacing about 70% to 80% of pre-retirement income. That means it’s essential to save for retirement by contributing to a 401(k) plan or funding a Roth IRA or traditional IRA.

While Social Security isn’t meant to be the only source of income in retirement, that’s the reality for many older Americans. About half of seniors rely on Social Security for at least 50% of their income and roughly one in seven retirees depend on it for 90% or more, according to the Center on Budget and Policy Priorities.

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5. Who Pays for Social Security?

You do, taxpayer. So does your employer.

Social Security is funded via payroll taxes, which are also sometimes referred to as FICA taxes.

Most workers have 7.65% of their paychecks automatically deducted for FICA taxes. Your earnings are taxed at 6.2% for the first $160,200 of earnings as of 2023. Anything you earn above that isn’t taxed for Social Security — which is why $160,200 is the maximum amount considered for calculating your benefits.

The remaining 1.45% goes toward Medicare, but for that there’s no salary cap. In fact, individuals who earn above $200,000 and married couples making more than $250,000 get hit with an extra 0.9% Medicare tax.

Your employer matches your 7.65% contribution toward Social Security and Medicare. That means self-employed people pay 15.3% because they have to make both the employee and employer contributions.

6. Is It True That Social Security Is Going Broke?

Not exactly.

What’s really going on is that Social Security is at a tipping point. In 2021, Social Security started taking in less money than it pays out, thanks mostly to longer life expectancies and people having fewer children — which means fewer workers paying into the system.

While Social Security has a $2.9 trillion trust fund it can dip into, the funds are expected to be depleted by 2035. But that doesn’t mean the program is doomed. Social Security is funded on a pay-as-you-go basis.

Even as it starts depleting its trust fund, it will still be collecting payroll taxes from workers and employers. If the trust were to run dry in 2035, payroll taxes would still generate enough to pay for about 79% of the program’s obligations if Congress does nothing.

But there are plenty of 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, as it did in 1983.

It’s pretty unlikely that Congress won’t take action. A Pew Research Center poll found that 74% of Americans oppose cutting benefits. Lawmakers on both sides of the aisle are keenly aware of the program’s popularity among voters.

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.

But if you take Social Security early, your benefits will be reduced by $1 for every $2 you earn above $21,240 in 2023. You get more leeway during the year you reach full retirement age: You’ll have $1 withheld for every $3 you earn above $56,520, and then once you actually hit that age, your benefits will no longer be reduced.

8. Are Social Security Benefits Taxed?

If you have additional income, whether it’s from a job or investments, there’s a good chance at least part of your Social Security will be taxed. Here’s how it breaks down.

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.

Keep in mind that “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 simply 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. Social Security only includes half your benefits when determining your income.

Of course, if you’re still working and saving for your retirement, here’s where we’ll give a shoutout to Roth IRAs and Roth 401(k)s. By forgoing the tax break during your working years, you get tax-free income in your retirement years — income that doesn’t count against you for Social Security purposes.

In the example above, 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 wouldn’t count against you, meaning that you’d fall below the $25,000 income threshold. That means 0% of your Social Security benefit would be taxable.

If Social Security is your only income source, you probably won’t be taxed on it, considering that the average benefit amounts to just $21,924 per year.

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9. What’s the Best Age to Take Social Security?

There’s no perfect age to take Social Security. And unfortunately, a lot of people don’t have the option to delay benefits because they’re forced to retire early due to health concerns, a job loss or the need to care for a spouse or parent.

Obviously, if you want bigger monthly checks, you’d wait as long as possible. If you want more checks over the course of your lifetime and are OK with them being smaller, you’d claim earlier.

If you have medical issues or your parents died relatively young, it’s worth considering starting benefits earlier. You’d wait as long as possible if you’re in good health, especially if you’re worried about outliving your money.

Sometimes spouses 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 can still get Social Security retirement benefits based on a current, former or deceased spouse’s record even if you’ve never worked. Otherwise, you’ll need to pay into the system to collect benefits.

Children of a deceased worker qualify 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 can also qualify for survivors benefits.

11. How Do You Apply for Social Security?

You can easily apply for Social Security online in about 15 minutes. You can also visit your local Social Security office or call 800-772-1213 between 8 a.m. and 7 p.m. Monday through Friday.

12. Can You Reverse Your Decision to Start Benefits?

Yes, but your options for reversing your Social Security decision are extremely limited: If it’s been less than a year since you started benefits, you can withdraw your application and repay all your benefits, including Medicare premiums, taxes you opted to withhold and benefits your family received on your behalf.

If you’ve reached full retirement age, you can suspend your benefits so that you can 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 writer at The Penny Hoarder. She writes the Dear Penny personal finance advice column. Send your tricky money questions to [email protected].