Social Security retirement benefits are paid via a United States government program which essentially mandates you to save for retirement. Whether you are an employee or self-employed, you are required to contribute a portion of your earnings to the Social Security program. If you are an employee, you pay Social Security tax of 6.2% up to the Social Security taxable wage limit. Your employer contributes another 6.2% based on those same earnings. If you are self-employed, you pay both the employer and employee portions, or 12.4%, up to the wage limit.
The wage limit generally increases each year based on the average increase in wages. For 2017, the amount of wages subject to Social Security tax is $127,200. In exchange for these tax payments, you will receive Social Security retirement benefit payouts to help you during retirement in your later years.
Discussing Social Security retirement benefits can sometimes get a bit complicated. Knowing some of the basics can help you to understand your options and to make more informed choices.
Social Security Retirement Benefits Alone May Not Be Enough
Now granted, Social Security benefits ideally should not be your only source of income at retirement. According to the Social Security Administration, Social Security benefits replace about 40% of preretirement income for the average worker. In order for the average worker to have a comfortable retirement financially, they may need closer to 70% or 80% of their preretirement income.
So you should save additional money separate from your social security tax withholdings. You can fund an employer 401(k), a small business retirement plan, or a traditional or Roth IRA, for example. These vehicles allow you to accumulate money in a tax advantaged way. But now back to the topic of Social Security.
Are You Eligible for Social Security Retirement Benefits?
Generally, you need to work at least 10 years (40 credits) in order to qualify for retirement benefits. You can get a maximum of 4 credits each year. The amount of earnings needed for a credit generally increases each year with the increase in average wages. In 2017, you must earn $1,300 to earn one credit for the year. So once you earn $5,200, you’ve earned your maximum credits for 2017. The credits do not have to be earned consecutively. You are allowed to have gaps in your work earnings history in meeting this minimum.
You may also be eligible for benefits if you are a spouse, divorced spouse, child, or widow/widower of a worker who has earned the required credits. However, there are family limits as to how much can be paid out based on a single worker’s earnings record. See below for more information.
How Much Will You Receive In Social Security Benefits?
The primary factor which determines your retirement benefit is how much you earned during your working years. The higher your earnings, the more you will receive in benefits up to a limit.
Consistent earnings will also help you to get a higher benefit. Years for which you did not work or had relatively low earnings may contribute to a lower benefit. If you stop working due to an illness or injury, you may be eligible for Social Security Disability Insurance (SSDI) benefits. Click here to read more about disability insurance, including SSDI.
Computing Average Indexed Monthly Earnings (AIME)
Your earnings are first indexed to today’s dollars. Then the highest 35 years of earnings are used to compute your benefit. Keep in mind that each year’s earnings considered for this purpose cannot exceed the maximum wage base on which you owe Social Security tax. This is also why your monthly benefits cannot exceed a certain maximum limit each year.
For example, if you earned $150,000 in 2016, only $118,500 will be counted as earnings during that year on your earnings record. Because this was the Social Security wage base limit in 2016. If you made $50,000 in 2016, then this would be the amount on your earnings record.
The total indexed earnings of the highest 35 years is divided by 420, or the number of months in 35 years. The result is the AIME.
Apply Percentages to AIME to get Primary Insurance Amount (PIA)
A formula is then applied to the AIME amount to compute the PIA. This formula consists of different percentages applied at different points of AIME called “bend points.” These bend points are adjusted annually for inflation. If your full retirement age is in 2017, for example, the first $885 of AIME is multiplied by 90%. Any AIME between $886 and $5,336 is multiplied by 32%. Finally, any AIME in excess of $5,336 is multiplied by 15%. The sum of these three parts is equal to the PIA. The PIA is the benefit you would receive if you started collecting benefits at your full retirement age.
The maximum monthly benefit for those first collecting benefits in 2017 at full retirement age is $2,687. If you start collecting early at age 62 in 2017, your maximum will be $2,153. This represents a reduction of 20%. If you start collecting at age 70 in 2017, your maximum benefit would be $3,538, an increase of over 31% over the regular full amount.
Full Retirement Age (FRA)
The age at which you retire and choose to receive your Social Security benefits will also affect your benefit amount. Age 62 is the earliest age at which you can receive benefits. But choosing to collect be benefits at this age will result in a reduced benefit. The reduction varies, but can be as high as 25% to 30%.
In order to receive your full retirement benefit, you must wait to collect until you reach your FRA. Your FRA varies depending upon when you were born. The minimum is 65, and the maximum is 67. For example, for those born before 1938, their FRA is 65. Those born between 1943 and 1954, it is 66. And if you were born after 1959, it is 67.
When you are ready to start collecting benefits, you should apply about three months earlier. It is recommended however, that you sign up for medicare three months before your 65th birthday, even if you will be collecting your Social Security retirement benefits at a later age.
Delayed Retirement Age
You can also delay collecting benefits past your FRA. Your retirement benefit will increase the longer you wait, up until age 70. You increase your benefit by about 8% each year you delay. So if your FRA is 66, you can get up to 132% of your PIA if you delay until age 70.
When Should You Start Collecting Social Security Retirement Benefits?
This is a personal decision which may depend on many factors. These may include your current and future cash needs, retirement savings, work situation, health, and family longevity. If you have current cash needs, low retirement savings, are out of work, and/or have health issues or a short family longevity, you probably want to take the benefits sooner rather than later. The opposite is also true.
Keep in mind that if you wait longer to receive benefits, it can take several years to make up the foregone benefit payments. For example, let’s say your reduced benefit is $750 per month at age 62, or 25% lower than your hypothetical age 66 FRA benefit. If you collect benefits early, you will have collected $36,000 in this example by the time you reach full retirement age.
Continuing with our example, if you wait until age 66 to start collecting, it will take you 3 years to collect these benefits you would otherwise forego by waiting four extra years. So the benefit of the higher FRA payment won’t kick in until after 3 years in this example.
This is not necessarily an endorsement for taking benefits earlier. If you are in good health, working, and don’t need the cash, for example, it may pay to wait for a higher monthly benefit.
Family Benefits
Your spouse, divorced spouse, and children may also receive benefits based on your work history while you are collecting your benefits. Widows and widowers can also receive benefits based on a deceased spouse’s work record.
Spouse
Your spouse can also collect benefits based on your record if at least 62 years old, or younger if taking care of a child younger than 16 or disabled (before age 22).
If you do not qualify for your own retirement benefits, you can get up to half of your spouse’s full benefits when they start collecting. If you are eligible for your own, as well as spousal benefits, you will receive the higher of the two.
Spousal benefits collected before your FRA will also be reduced. If your spouse applies for spousal benefits at 62, they will receive between 32.5% and 37.5% of your benefits. The amount increases to the maximum of 50% as they reach their FRA. A spousal benefit is not reduced due to early application if caring for a child (see above).
Children
Your children can collect payments at the same time as you as long as they are unmarried, under 18, or 18-19 if a full-time student and not yet graduated from high school. Disabled children can receive benefits even if they are over 18 years of age. But they must have been disabled before age 22. As with a spouse, children can get up to half of your full retirement benefit.
Children may also receive Supplemental Security Income benefits if disabled and their parents have limited income or resources. See the Social Security Administration website or call them for more information on this type of benefit.
Maximum Family Benefits
The payments based on your own earnings record to a spouse and children in total cannot exceed the limit for the entire family. This limit generally falls between 150% and 180% of your own retirement benefit payment. If the limit is exceeded, the spousal and child benefit payments are reduced.
If a spouse collects spousal benefits and also qualifies for his or her own lower benefit, only the difference counts towards the family limit. The spouse is deemed to collect their own benefit first based on their own earnings record first, if any. Then they receive the difference if the spousal benefit is greater. The family limit is based on each individual’s earnings record. So any benefits paid under someone else’s earnings record do not count towards your own record’s family limit.
Divorced Spouse
A divorced spouse can also receive benefits based on your work history. However, the marriage must have lasted at least ten years. Also, the divorced spouse must be at least 62 year old, and unmarried. The benefits of a divorced spouse do not affect your own or your current spouse’s benefit. They also do not count towards the family maximum.
Unlike with a current spouse, a divorced spouse does not have to wait until you begin collecting benefits. However, you both must be at least 62 years old and have been divorced at least two years.
Widows and Widowers
The maximum survivor benefit is equal to what the deceased spouse would have collected if they were still alive. Survivor benefits do count towards the family maximum.
You can start collecting survivor benefits as early as age 60 (50 if you are disabled). This will be a reduced benefit of your deceased spouse. But you can then switch to your own full benefit if it is more. Switching can occur as early as 62, at full retirement age, or as late as age 70.
You Can Still Work While You Collect Benefits
Working is still an option even after you start collecting benefits. If you work after reaching your FRA, your benefits will not be reduced. This includes the month in which you reach your FRA. However, working before the month in which you reach your FRA may result in a reduction in benefits if earnings exceed certain limits.
Taxability of Benefits
The Social Security Administration estimates that about 40% of those who receive Social Security benefits have to pay taxes on that income. Paying tax on benefits generally depends on the amount of your other income. You cannot pay taxes on more than 85% of your benefits.
Conclusion
You can see your history of annual earnings on file with the Social Security Administration by creating an account at www.ssa.gov. Their website provides useful information and tools. Signing up for an account will also allow you to see more accurately what your expected benefits will be based on your actual work history.
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