Social Security. Most of us know what it is―a monthly benefit issued by the federal government and payable once we retire. But do you really know how the program works and how it can affect your retirement?
1. An overview of Social Security
Social Security was established as a national pension plan in 1935 during the height of the Great Depression, when many working-class and middle-class families were struggling to make ends meet.
By 1933, unemployment reached 25 percent and over 13 million Americans had lost their jobs. The Social Security Act of 1935 aimed to reduce the hardship and uncertainty facing millions of Americans at retirement by paying out a monetary benefit based on your work history.
Qualification is fairly straightforward. You earn Social Security based on credits earned during your working life. You receive one credit for every $1,300 you earn, up to a maximum of four per year. If you work a full time job for at least ten years, you qualify for Social Security benefits, assuming Social Security taxes are deducted from your paycheck or you pay them separately as an independent contractor.
The Social Security Administration (SSA) calculates your benefit by averaging the best 35 years of your career during which you earned the most. If you worked less than 35 years, the formula is the same except with some years calculated as zero.
If you only worked for 30 years, for example, the SSA would take the average earnings of those years plus five years as zero for a total of 35.
2. How Social Security plays into your retirement plan
If you're currently 55 or older, you'll most likely get the full Social Security benefits you're supposed to. Because of recent discussions about reforming Social Security, the future for those younger than 55 could be a little murkier.
Those 55 years old or younger could face a 23 percent reduction in payouts after 2035, with the possibility of further reductions each year thereafter depending on whether or not political leaders make the intended reforms a reality.
Most retirees will require 70 percent of their pre-retirement income to maintain their standard of living at retirement, but Social Security only provides about 40 percent of that. That statistic doesn’t bode well, given that 43 percent of unmarried individuals and 23 percent of married couples rely on Social Security for 90 percent of their income or more.
On the other side of the coin, if you reach the full retirement age of 70 when you start claiming benefits―and are well off financially―you will receive maximum benefit payments and could potentially use those benefits as a revenue stream for investing.
The picture gets a little more complex if your spouse is also claiming benefits or if you are receiving a pension from the military or other source. Still other considerations come into play.
Do you plan on working part time in retirement or becoming an entrepreneur? Do you have other savings or income-generating accounts to further your retirement plans or lifestyle? The bottom line is that your financial security in retirement is your own responsibility, and you will need to set aside as much money as possible to invest wisely and get the most out of retirement.
3. How and when to claim Social Security
At the back of every worker’s mind is the dream of enjoying a stable, comfortable retirement with the time to enjoy more leisurely activities than our parents or grandparents did. It’s another piece of the American dream.
However, there are a lot of pieces to the puzzle of achieving a secure retirement―many of which require careful financial planning and careful consideration of when to start receiving benefits.
You should apply for retirement benefits about four months before you want to start receiving payments from the SSA. You can start receiving benefits at age 62 rather than wait until your full retirement age (FRA), but you will likely see a 30 percent reduction in monthly benefits. Every year you wait past your FRA up to age 70, you get an 8 percent increase in benefits.
Your health, expected longevity, and lifestyle are three important factors that go into deciding when to claim benefits. If you can afford to wait, do it for maximum benefit potential.
Certain groups of workers—including railroad employees, teachers, and some government workers—are not covered by Social Security because they’re enrolled in other pension systems instead. In some cases, they may be able to draw reduced Social Security benefits as well as their pensions, but the rules are complex.
If you fall into one of these worker categories, contact your local Social Security office for guidance. The SSA offers a very useful benefits planning tool that could help answer some of these benefits questions.
4. Next steps
The golden years of retirement can be some of the best of your life if you’ve carefully planned for them financially.
Before you retire, take a step back and envision what kind of lifestyle you want and whether or not you have the financial resources to make that happen. If you have the money, consider relatively safe investment vehicles, like an annuity that allows you to convert some of your assets into income for life.
Lastly, Social Security and retirement investing can be complicated, with many factors that need to be fully understood in order to maintain or grow your assets. A financial advisor may be able to answer many of your retirement questions and make the entire process as stress-free as possible.