Social Security is a subject that has significant importance to almost all working adults. Young adults worry that it won’t be around, Pre-retires wrestle with when they should claim, and those already receiving Social Security benefits question the cost of living adjustments, or lack thereof, that can increase their benefit over time. Unfortunately, most of the articles about Social Security focus on it running out of money or contain claiming strategies that have largely been eliminated by the Bipartisan Budget Act of 2015.
We have a more positive view of Social Security for the guarantees it provides and the flexibility in planning it allows. We also don’t want to leave anyone out so this article will cover the state of Social Security, the ins and outs of claiming, and some historical context so those receiving benefits can see what they might expect moving forward. We’ve covered some of the basics before but thought a more thorough rundown was long overdue. Let’s dive in.
Will Social Security run out?
That is a great question! Before we invest our time to learn about Social Security we should find out if it will be around or not. What did the chief actuary of the Social Security Administration have to say about it in his 2010 report?
“The concepts of solvency, sustainability, and budget impact are common in discussions of Social Security but are not well understood. Currently, the Social Security Board of Trustees projects program cost to rise by 2035 so that taxes will be enough to pay for only 75 percent of scheduled benefits. This increase in cost results from population aging, not because we are living longer, but because birth rates dropped from three to two children per woman. Importantly, this shortfall is basically stable after 2035; adjustments to taxes or benefits that offset the effects of the lower birth rate may restore solvency for the Social Security program on a sustainable basis for the foreseeable future. Finally, as Treasury debt securities (trust fund assets) are redeemed in the future, they will just be replaced with public debt. If trust fund assets are exhausted without reform, benefits will necessarily be lowered with no effect on budget deficits.”
For the sake of simplicity let us explain it this way. If Congress can’t agree to any changes to fix this, then expect future benefits to be about 75% of what they are today (some more current analysis puts that closer to 80%). That means if you were receiving a benefit of $2,000 a month today, it would be reduced to $1,500-$1,600 a month. The same would apply to future projected benefits being presented to those who have yet to claim. Our current and projected tax revenue could sustain that 75% level indefinitely. Certainly painful, especially so for those already retired, but it definitely wouldn’t run out.
So, what is the solution? In the same 2010 report they gave two. Immediately reduce the benefit by 13% or increase the payroll tax by 2%. Either, or some combination of the two, would have done the trick. As you know by now neither occurred. Why? Politics.
For starters messing with benefits already being paid out is political suicide. We can’t foresee a scenario where they cut benefits from those already receiving it. Increasing payroll taxes is only slightly more likely as it directly impacts not only consumer spending but every voting age American still working. The two options that seem most plausible are increasing the amount of income subject to the Social Security tax ($132,900 in 2019) and changing the age to qualify. The increase on income levels taxed is going up anyway due to inflation adjustments so accelerating that a small amount would not be too noticeable. Second, given the prospect of many young workers living longer lives and working later in life, pushing out early retirement and full retirement age another year or so is more likely.
The conclusion is that if you think Congress will eventually be forced to act expect them to take the path of least resistance and one that affects the smallest voting bloc. If you think Congress will never agree on a solution, then you can discount Social Security payments by 25% for your retirement projections. Either way we feel comfortable saying that it isn’t going away.
How is Social Security earned?
Now that we know it will be around in some form, how do you get it? Eligibility for Social Security is granted by earning credits. In 2019 you earn one credit for each $1,360 of earnings up to the maximum of four credits per year. These credits stay with you throughout your life so if you stop working and then start again you keep all the credits you previously accrued. Once you earn a total of 40 credits you will be fully eligible for retirement benefits. If you do the math it means by earning the maximum 4 credits per year it will take you only 10 years to become fully eligible.
There are exceptions to this we won’t cover in detail. Know that if you become disabled at a younger age the requirements to fully qualify for benefits is lowered. For example, a 35-year-old who becomes disabled would need 20 credits to be fully eligible. Also, if you pass away prior to earning your 40 credits your family may still be eligible for survivor benefits.
How are Social Security payments calculated?
Once you earn your 40 credits what are you entitled to? That is determined by a formula using your average indexed monthly earnings (AIME) that works like this. Social Security uses your 35 highest earning years to calculate your benefit. They adjust older earnings for inflation so they can be compared to today’s levels to make the calculation. Then they add them all up, divide by 35 years, and then divide by 12 to get the monthly average. A fancy formula is applied to that average to get your Primary Insurance Amount, or PIA as we will call it moving forward. Your PIA is the monthly benefit you would get if you claimed Social Security at your full retirement age.
If you don’t have 35 years of earnings to use, then a $0 will be filled in for those missing years. Workers with a short history can really be hurt by that and often aren’t aware how much they could benefit from extending their working years, even on a part time basis.
If you claim before or after your “Full Retirement Age” that can decrease or increase your benefit. Your full retirement age, or FRA from here on out, is the age at which you become eligible for a full, unreduced retirement benefit. Your FRA depends on when you were born.
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If you were born from 1943 -1954 your full retirement age is 66
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If you were born in 1955 your FRA is 66 and two months
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If you were born in 1956 your FRA is 66 and four months
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If you were born in 1957 your FRA is 66 and six months
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If you were born in 1958 your FRA is 66 and eight months
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If you were born in 1959 your FRA is 66 and ten months
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If you were born in 1960 or later your FRA is 67
When you decide to claim Social Security before or after your FRA the impact on your Social Security payments can be significant. If you were born after 1960 your retirement benefit would be reduced by 30% by claiming at age 62, which is the earliest age you can claim your own retirement benefit. Similar drops are applied along the way with claiming at 64 resulting in a 20% benefit reduction. Here is a full chart showing the affects (link). On a more positive note, every year you delay claiming after age 67 results in an 8% increase in your payment. That is a 24% bump available to those who can afford to wait.
What are all the ways to claim Social Security?
This question could probably be a book. Amazon alone lists thousands of Social Security related books (of course any written prior to 2016 are essentially useless because of changes to the claiming rules). We will review the most common but remember that you may qualify for more than one path to claiming.
Claim based on your own benefit: This is like everything described above where you have worked enough to earn your 40 credits and are qualifying based on your own earnings history. When you claim impacts the amount payable and you will receive that benefit, with cost of living adjustments, for the rest of your life.
Claim based on your spouse’s benefit: Even if you have never worked you can qualify for benefits based on your spouse’s work history if they have already claimed. Claiming spousal benefits will provide up to 50% of their full retirement age benefit. Just like claiming on your own record, if you do so before your full retirement age your spousal benefit is reduced. Delaying beyond FRA, however, does not increase your spousal benefit like it would for you individually.
If you could claim social security under both your record and your spouse’s, then Social Security follows the deemed filing rules to determine what happens. What this means is you can’t file for spousal benefits without filing for your own. First, Social Security will determine which one is higher. If your own is higher then you will just receive that benefit. If your spousal benefit is higher then you will receive your benefit plus an additional amount until it matches the spousal benefit due.
Another wrinkle is if you claim on your record and your spouse claims later making you eligible for a spousal benefit that is higher than your own. This would make you eligible for a bump up in your benefit equal to half of your spouse’s PIA minus your PIA amount. For example, your PIA was $800 a month but you claimed early and are receiving $600 a month. Your spouse claims with a PIA of $2,100 a month. You would now be entitled to $1,050 (half of theirs) minus $800 (your PIA), or $250 additional. Social Security would take your current $600 benefit and add $250, bringing your new monthly benefit to $850. As you can see you are still penalized for claiming early, even when you switch to a spousal benefit down the road.
Claim based on an ex-spouse’s benefit: Claiming off an ex-spouse’s benefit has lots of additional requirements. First, you must have been married for 10 years or longer. Second, you must be divorced for more than two years. Third, your ex-spouse must be entitled to receive a retirement benefit (although they don’t need to have claimed like current spousal benefits). Fourth, you must be at least 62 years old. Fifth, your benefit based on your own work history must be less than the ex-spousal benefit. Finally, you must not be remarried, unless it is after age 60.
Once you meet all the requirements listed above you would be eligible to receive up to 50% of your ex-spouses PIA. Just like a current spousal benefit, it is reduced if you claim it prior to your FRA but doesn’t increase if you delay taking it beyond FRA.
This method of claiming is not without its misunderstandings. If you file a Social Security claim on your ex-spouses record it WILL NOT impact their benefit, it WILL NOT impact their current spouse’s benefit if they remarried, and they WILL NOT be notified in any way that you are doing so. In addition, if you’ve been married for more than 10 years multiple times, you can only claim one assuming it is more than your own benefit.
Claim based on a deceased spouse’s benefit: If your spouse is already collecting Social Security benefits and passes away you are eligible to collect 100% of their benefit, with a few exceptions. The same rule always applies that you can’t receive two benefits so if you are collecting your own already and it’s higher you can’t receive both. You must have been married for at least nine months (unless the death was accidental). You also need to be at least 60 years old to claim but doing so before your FRA will reduce this benefit.
One lessor known provision of claiming a survivor’s benefit is the Retirement Insurance Benefit Limit. This only applies when the deceased spouse was receiving a reduced benefit due to claiming early. If the deceased started their benefits before their FRA, the surviving spouse would receive a minimum of 82.5% of the deceased’s PIA. If one spouse had claimed at age 62, and was therefore only receiving 70% of their PIA, this provision helps boost the surviving spouses Social Security benefit. From 2010 to 2016 10% of all Social Security payment miscalculations involved this benefit (SSA 2017 Agency Financial Report) so it is worth reviewing if the situation applies to you.
If you have not started receiving your own benefit you are able to claim your survivor benefit and delay claiming on your own record until a later date. Survivor benefits do not follow the deemed filing rules like spousal benefits do. Your own benefit earns credits when you delay beyond your FRA, but a survivor benefit doesn’t. In some instances, taking the survivor benefit as early as possible and switching to your own benefit at age 70 may be beneficial.
Can I claim Social Security while I’m working?
If you are still working while collecting a Social Security benefit and have not reached your FRA, your benefits will be reduced by $1 for every $2 that you earn above the annual limit (which is $17,640 for 2019). Beyond your FRA there is no restriction. In the year you retire a higher annual limit is allowed ($46,920 in 2019) and a lower reduction ($1 for every $3 that you earn) for those that don’t want to retire at the beginning of the year but start Social Security right away. Earnings for the year are only counted up to the month before your full retirement age. Also wage income is counted in the month/year it is earned, not received, but self-employment is the reverse. Income from self-employment counts when you receive it, not when it is earned.
For Social Security purposes income is classified as wages, or net earnings if your self-employed, contributions to pension or retirement accounts if it is included in gross wages, and bonuses, commissions, and a few other employer related payments. It does not count investment earnings, government benefits, annuities, inheritances, or pensions.
When you receive a reduction in benefits due to exceeding the earnings limit, that amount is withheld up front. For example, if your benefit amount was $9,600 a year and you earned $27,640 during the year, you would have exceeded the 2019 limit by $10,000. This results in a $5,000 reduction in benefits. Instead of reducing each monthly payment by about $416, 100% of your benefit is withheld for the first seven months, when it surpasses $5,000, and a full monthly benefit will start after that. Any additional amount beyond the $5,000 that was withheld ($600 in this example) is refunded the following year.
The $5,000 that was withheld is not lost forever. Any benefit reduction due to your work earnings will be recovered starting in January of the year after you reach your FRA, although on a gradual basis spread out over your life expectancy. Realistically this means that you really need to meet, or exceed, the average life expectancy to get this money back.
Anyone receiving retirement benefits based on their own work history is not affected by a spouse continuing to work and earn income. Spousal benefits are another matter. If your spouse is claiming off your earnings record then your income can result in not only your benefit being withheld, but your spouse’s as well.
One additional point, continuing to work can increase your wage base that Social Security uses to calculate your payments (highest 35 years of income, inflation adjusted) which may offset some of the reduction of claiming early. This is especially important for anyone who doesn’t have a full 35 years of work history built up because even part-time work can add some income to replace a $0 year.
How much of my Social Security benefit is taxed?
Put another way, how much of my social security check do I get to keep. The percentage of your Social Security benefit subject to income tax is based upon your income level, but not using the same standards as for the earnings test described earlier. For taxation purposes, income includes money earned from employment or self-employment, distributions from pre-tax retirement plans, investment earnings, pensions, qualified US savings bond interest, and tax–exempt interest. To calculate your combined income from all these sources, add Adjusted gross income + non-taxable interest income (typically from municipal bonds) + ½ of your Social Security benefit.
Combined Income % of Social Security benefit taxed
Single – $0 – $24,999 0%
Single – $25,000 – $34,000 Up to 50%
Single – Over $34,000 Up to 85%
Married filing jointly – $0 – $31,999 0%
Married filing jointly – $32,000 – $44,000 Up to 50%
Married filing jointly – Over $44,000 Up to 85%
One important opportunity to consider is that distributions from Roth IRAs are NOT included for income calculations here. This may present an opportunity to layer Roth IRA distributions on top of IRA ones to achieve the income level desired but fall in the 50% Social Security tax level.
When should I file for Social Security benefits?
Probably the most frequently googled question regarding Social Security retirement benefits is when we should file. There is no shortage of answers because there are an endless number of factors to consider. The truth is you should always strive to understand ALL the claiming options available to you before you start. If you are single and were never married this helps quite a bit. If you are currently married or had a previous marriage lasting more than ten years options begin to multiply. First let’s identify some of the major factors.
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Employment Status – Your current employment status is a big contributor to deciding when to claim because of the earnings test prior to FRA and the tremendous 8% annual increase in benefits given to those who delay beyond FRA. If you have stable employment that pays enough to support your needs, then it doesn’t make sense to claim early only to have the benefit withheld. If you can keep your job until age 70 then you win the trifecta of a 24% larger benefit (with Cost of Living Adjustments based off the higher amount for life), fewer years of retirement to pay for from savings, and additional years to grow your retirement accounts tax deferred. However, if you really dislike your current job, your quality of life might trump what the numbers say and that is ok.
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Health – One common thought is to compare how long it would take until claiming a smaller benefit early equals getting a larger payment later in terms of total dollars received. The rule is if you live beyond that “breakeven” point you win by delaying and if you pass away before then you would have been better off claiming early. We’re not a fan of using only this framework because it doesn’t consider several key points. If you’re married and were the primary earner in the household, you are reducing the survivor benefit available for your spouse when you pass away and claimed early. Also, if you could afford to delay, then you could also invest the money you received from claiming early. Now you are comparing the benefit increase received each year to a hypothetical rate of return, which can get tricky. Probably a better way to think of this is do you value more flexibility by having the money in hand or protection against longevity from a guaranteed larger lifetime payment.
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Marital Status – If you are married then you need to be considering a joint life expectancy, which tends to make the longevity protection Social Security provides more valuable. Another variable is your maximum possible combined benefit. If one spouse will be better off with a spousal benefit then their own, even if it is delayed, then holding out until 70 may make no sense. One final thought is the complexity if one spouse is subject to the WEP or GPO (Windfall Elimination Provision and Government Pension Offset). That is a reduction in Social Security benefits for you or a spouse due to receiving a pension from a government agency or employer who did not withhold Social Security taxes (more on this later).
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Money Saved – Some retirees have saved enough to comfortably live well beyond reasonable life expectancies, even without Social Security benefits. In that case longevity protection isn’t a priority. These cases may hinge on which scenario results in the lowest amount of lifetime taxes paid or the largest legacy to be left to beneficiaries. At the opposite end of the spectrum are the 29% of Americans with no pension or retirement savings according to the latest estimates from the U.S. Government Accountability Office. Their choice will be solely determined by when they stop working because they NEED the income now. Unfortunately, a 2019 study from The Center for Retirement Research at Boston College cited over one-third of older workers are retiring earlier than planned, with health shocks playing the largest role. In essence, they may not even have a choice about when they stop.
Can my Social Security benefit increase over time?
The answer is yes and in several ways. The primary ways your benefit can increase over time is through cost-of-living adjustments, adding to your work history, and a return of previously withheld benefits.
The most common is through annual cost-of-living adjustments. Social Security’s annual cost-of-living adjustment (COLA) is determined by the inflation readings from the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), which is released annually in October. The CPI-W measures the price movements of a predetermined basket of goods and services on a year-over-year basis. Basically, the Department of Labor has compiled statistics on a lot of everyday things that we all buy and measures how much it costs us to buy them compared to last year. If the cost has gone up (inflation) then Social Security recipients will get an increase in the benefit the following year. If the cost has gone down (deflation) then benefits will stay the same (they will never decrease).
Since 1975 the average COLA has been 3.73%, but since 2005 it has only been 2.08%. Since 1990 we have only had one cost-of-living adjustment above 5%, which came in 2008 at 5.8%. This is problematic because health care costs have exceeded average inflation with an average growth over the next decade projected at 5.5% according to the Centers for Medicare & Medicaid Services. COLAs just haven’t kept up with one of the larger growing costs of retirees.
Adding years of higher income is another way to increase your benefit over time. Your PIA amount is based on your 35 highest earning years, adjusted for inflation, so every year worked is an opportunity to boost your lifetime benefits. This is true even if you have already claimed Social Security. While it seems a bit odd historically, people working past 70 may become much more common as life expectancies increase. There currently is no benefit to delaying past age 70. This could lead to many more people’s full benefit growing after claiming due to additional high-income work history being tagged on after age 70.
Finally, anyone who worked while receiving benefits prior to their FRA may have had benefits withheld. This works by counting the number of months benefits were withheld for and recalculating your benefit amount when you reach FRA. For example, if your work resulted in 12 months of withheld benefits in total, when you reach your FRA Social Security will recalculate your benefit as if you had claimed your benefits one year later than you actually did. This is meant to roughly replace the amount of income lost by your average life expectancy. If you never reach your full life expectancy, there is no way to recoup the withheld benefits.
What are we forgetting?
What are we forgetting to mention? Probably a lot. As much as we just covered, there are mountains of scenarios left untouched. We will briefly summarize a few here.
Social Security Do-Over – Between age 62 and FRA you have up to 12 months after you file for benefits to change your mind. This will require you to repay ALL the benefits you, or anyone else, received based on your filing but has no negative impact on your long-term benefits when you do file again. You can do this once in your lifetime. If you are past your FRA, but not yet 70, then you can ask Social Security to suspend your benefits. During this time, you can receive delayed retirement credits which will boost your payment once you start it again. Be careful that suspending your benefit also suspends other benefits based on your work record, like spousal benefits, and stops any payments for Medicare part B you may have had automatically deducted.
Windfall Elimination Provision – Social Security describes it this way: “This provision can affect you when you earn a retirement or disability pension from an employer who didn’t withhold Social Security taxes and you qualify for Social Security retirement or disability benefits from work in other jobs for which you did pay taxes.” Those who did not have taxes withheld for Social Security are usually teachers or government workers. Today most government workers will not be impacted because they switched from the Civil Service Retirement Systems (CSRS), which didn’t withhold taxes, to the Federal Employees’ Retirement System (FERS) which does. Depending on how many years you worked with substantial earnings under Social Security dictates how much your benefit would be reduced. If you worked more than 30 years paying into Social Security this provision will not apply to you.
Government Pension Offset – If you earn a retirement or disability pension from a local, state, or federal government agency who didn’t withhold Social Security taxes, your spousal or survivor benefit may be reduced by two-thirds of your government pension. There are almost a dozen exceptions to this, so it is important to analyze for specific situation to know if it applies. Many couples overlook this and unfortunately a surviving spouse ends up with a lot less income than they had planned on.
Retroactive Benefits – Benefit claims beyond FRA can be done retroactively up to six months. This means that if you reached FRA in March of 2018, but waited to file until March of 2019, you could file retroactively back to September 2018 and get those months paid as a lump sum. Just be aware that this is the same as having claimed six months earlier, so it reduces your benefit by about 4%.
What you need to know about Social Security
Throughout your life there are a million small decisions you need to make that impact your financial future. Most are small and must compound over time to have a larger impact in aggregate. A few, however, are huge and have the potential to create a tremendous impact lasting the rest of your life all on their own. How and when you claim your social security benefits has both a huge impact and a lasting affect that can’t easily be undone. If you don’t recall any specifics from this writing, just remember that this is a complicated decision worthy of your time and attention. This is not a situation where you want to “follow your gut” or just accept the advice of a friend. Take your time because everyone’s situation is unique and there is a lot about Social Security you need to know to make the best decision.