There’s a lot of doom and gloom these days about Social Security’s solvency – or lack thereof. And regardless of whether you feel your Social Security future is secure, the fact is that you shouldn’t plan on living off your Social Security benefits. After all, Social Security wasn’t designed to make up a retiree’s entire income.
However, many people find themselves in a position to avoid their Social Security checks. And even if you have other sources of income in retirement, Social Security can make up a significant part of your retirement income plan. That is why it is important to know all the rules related to eligibility, benefit amount, taxation and more.
Who is eligible for Social Security benefits?
Anyone who has paid into Social Security for at least 40 calendar quarters (10 years) is eligible for retirement benefits based on their earnings record. Once you reach full retirement age, which is 66 and 67, you are eligible for your full benefits, depending on when you were born. But if you claim later than that – you can leave it as late as age 70 – you’ll get credit for doing so, along with larger monthly benefits. Conversely, you can claim as early as age 62, but taking benefits before your full retirement age will cause the Social Security Administration to dock your monthly benefits.
The bottom line: You’re eligible for Social Security benefits if you’ve paid into the system for at least a decade, but your actual benefits will depend on when you start claiming them — between 62 and 70.
How does the Social Security Administration calculate benefits?
Benefits also depend on how much money you have earned in life. The Social Security Administration takes the covered wages of your highest-earning 35-year-olds and averages them, indexed for inflation. They give you a big fat “zero” for every year you don’t earn, so people who work for less than 35 years may see fewer benefits.
The Social Security Administration also creates an annual cost of living even as you collect benefits. That means the retirement income you collect from Social Security has a built-in hedge against inflation. For many people, Social Security is the only form of retirement income they have that is directly tied to inflation. That’s a huge advantage that doesn’t get much attention.
Is there a maximum benefit?
Yes, there are limits to how much you can receive in Social Security benefits. The maximum Social Security benefit varies from year to year. For 2022, it’s $4,194/month for those who retire at age 70 (up from $3,895/month in 2021). Multiply that by 12 to get $50,328 in maximum annual benefits. If it is less than your expected annual expenses, you need to have additional income from your own savings to cover it.
What if I continue to work into my 60s?
Many people whose health allows them to continue working into their 60s and beyond find that being in the workforce keeps them young and gives them a sense of purpose. If you feel like there’s something you want to do, know that working after claiming initial benefits can affect the amount you get from Social Security. Why? Because the Social Security Administration wants to spread out your earnings so you can’t escape them. If you claim Social Security benefits early and then continue to work, you will be subject to the retirement earnings test.
If you’re between age 62 and your full retirement age, and you’re claiming benefits, you need to know the earnings test exemption amount, a threshold that changes every year. For 2022, the retirement earnings test exemption amount is $19,560/year ($1,630/month). If you’re in this age group and claiming benefits, every $2 you make above the exemption amount will reduce the Social Security benefits you receive by $1. (Note that only work income counts towards the earnings test, so capital gains and pension income will not count against you.)
Contrary to popular belief, this money does not disappear. It is credited back to you – with interest – in the form of higher future benefits. You may hear people grumble about the Social Security “earnings tax,” but it’s not really a tax. It’s designed to freeze your benefits to prevent you from spending too much too soon. And after you reach your full retirement age, you can work to your heart’s content without any reduction in your benefits.
Are Social Security benefits taxable?
If you have a lot of income from other sources, up to 85% of your Social Security benefits will be considered taxable income. If your combined Social Security benefits and other income is below $25,000, your benefits will not be taxed at all. The amount of your benefits that are subject to tax is calculated on a sliding scale based on your income. The money that Social Security recipients pay in income taxes on their benefits goes back into Social Security and Medicare funding.
If your retirement income is high enough that your benefits are taxable, how will you pay those benefits? If you want the government to withhold taxes from your Social Security benefits, you can ask Social Security for an IRS Voluntary Withholding Request form. Otherwise, you are expected to file a quarterly tax return to pay this tax during the year.
It covers federal income tax. What about state income tax? It depends. In 12 states, your Social Security benefits will be taxed as income, either in whole or in part; The remaining states do not tax Social Security income.
As you approach retirement, keep track of your expenses so you know how much income you’ll need to maintain your current standard of living. While conventional wisdom says that you don’t need to plan to replace 100% of your salary into retirement income, higher medical care costs in retirement may result in you needing as much money as you did when you were working. Our advice? Aim high and save as much as you can.
It’s a good idea to check back with a Social Security retirement income calculator periodically throughout your career. That way, you can see if you’re saving enough for retirement in other ways (401(k), IRA, etc.) to meet the money you can expect from Social Security. The best bet is to contribute early and generously to your retirement account—and not be overwhelmed by the mountain of money you’ll need to save.