A study by the Social Security Administration found that about half of the population over 65 relies on Social Security benefits for 50% or more of their family income. This highlights the importance of understanding not only the basics of how Social Security works and how it's calculated but also how to maximize your lifetime benefits. In this blog post, we'll cover the essentials and strategies to ensure you get the most out of your Social Security.
Social Security is funded through payroll taxes, not income taxes. You may have heard the term FICA, which stands for the Federal Insurance Contributions Act. Here's how it breaks down:
For 2024, the Social Security wage base is $168,600. This means you pay the 6.2% Social Security tax up to this amount. Earnings above this threshold are not subject to Social Security taxes and don't count towards benefit calculations. However, the Medicare tax of 1.45% applies to all earnings.
Social Security benefits are calculated using your 35 highest earning years. If you worked more than 35 years, only the highest-earning years are considered. This calculation adjusts your earnings for inflation, making historical earnings comparable to today's dollars. Your average indexed monthly earnings (AIME) are then used to determine your benefit.
The Social Security formula uses bend points, which ensure that lower earners receive a proportionally higher benefit. The bend points for calculating benefits are:
Your PIA is the monthly benefit you receive at full retirement age, which is between 66 and 67, depending on your birth year. You can claim benefits as early as 62 with a reduced benefit or delay up to age 70 for an increased benefit.
Social Security benefits may be taxed based on your provisional income, which is the sum of:
Depending on your provisional income, up to 85% of your benefits may be taxable.
Let's say you're a married couple with $30,000 in IRA withdrawals, $48,000 in Social Security benefits, and $5,000 in non-taxable interest:
Total Taxable Social Security: $18,750 out of $48,000.
Ensure you have a complete 35-year work history to avoid zeros in your benefit calculation. Social Security calculates your benefits based on your highest 35 years of earnings. If you have fewer than 35 years of earnings, zeros will be averaged in, which significantly reduces your monthly benefit. Even if you haven't worked consistently full-time, part-time work can fill in the gaps. For example, if you only worked 20 years and then took time off for family or other reasons, 15 years of zeros would be averaged into your calculation, drastically reducing your benefit. By ensuring that you have a full 35 years of earnings, even at lower incomes, you improve your overall benefit.
Waiting can significantly increase your monthly and lifetime benefits. Although you can start receiving Social Security benefits at age 62, your benefits will be reduced if you claim early. For every year you delay claiming beyond your full retirement age (between 66 and 67, depending on your birth year), your benefits increase by about 8% annually until age 70. For example, if your full retirement age is 67 and your primary insurance amount (PIA) is $2,000 per month, delaying benefits until age 70 would increase your benefit to approximately $2,480 per month. This increase can make a substantial difference in your lifetime benefits, especially if you live into your 80s or beyond.
These can provide higher benefits, especially if you or your spouse have lower lifetime earnings. Spousal benefits allow you to receive up to 50% of your spouse’s Social Security benefit if it’s higher than your own. This is particularly beneficial if one spouse earned significantly more than the other. For example, if your spouse’s benefit is $2,000 per month and your benefit is only $800, you could receive a spousal benefit of $1,000 instead of your own benefit, boosting your monthly income. Additionally, if you are divorced but were married for at least 10 years, you may still qualify for spousal benefits based on your ex-spouse’s earnings record, provided you haven’t remarried.
If your spouse passes away, you can claim their benefit as a survivor benefit, which might be higher than your own. Survivor benefits can be claimed as early as age 60 (or 50 if you are disabled). If your spouse’s benefit is higher than yours, claiming their benefit can provide a significant increase in your monthly income. For example, if your benefit is $1,000 per month and your late spouse’s benefit was $2,500, you could switch to the survivor benefit and receive $2,500 per month. Moreover, you can claim survivor benefits early and switch to your own higher benefit at a later date if it continues to grow due to delayed retirement credits.
Your Social Security strategy should be personalized based on your financial situation, health, and retirement goals. Consulting with a financial planner can help you make the best decisions for your unique circumstances. By taking these steps, you can ensure you maximize your Social Security benefits and enjoy a more secure retirement.
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