If you’re like most people, you’ll need Social Security retirement benefits to help you make ends meet in your golden years. That’s why it’s so important to understand the rules for these benefits.
Unfortunately, if you don’t know how the retirement income program works, you actually could find yourself inadvertently losing some of the money you were expecting.
To make sure this doesn’t happen to you, there are four situations you need to know about that could lead to a temporary or permanent reduction in your retirement income from the Social Security Administration.
1. Claiming benefits at the wrong time
You have the right to decide when you want to claim Social Security — but the decision you make could end up costing you if you don’t make the right choice.
Every retiree is assigned a “full retirement age.” This is based on the year when they were born. This could be as early as 66 and four months, or as late as age 67. If you claim Social Security prior to FRA, this results in a reduction in the standard benefit that you are entitled to based on your earnings over your career.
The reduction comes from monthly early filing penalties. These penalties add up to a 6.7% annual benefits cut for each of the first three years you claim ahead of full retirement age. If you start checks more than three years early, the penalties reduce benefits by another 5% for any prior year.
Retirees who wait beyond full retirement age aren’t subject to these penalties. In fact, they receive a benefits increase thanks to delayed retirement credits awarded monthly until age 70. These credits can increase your standard benefit by 8% annually.
It’s important to understand how these penalties and credits work to avoid losing benefits inadvertently. You’ll want to consider both monthly and lifetime income when deciding your optimum claiming age.
If you want the largest monthly checks, you should wait as long as possible to begin payments. However, if you are in poor health, you may want to claim benefits early. Waiting means forgoing income you could otherwise receive. While higher future checks laler can often make up for the missed income, this happens only if you live long enough to get plenty of larger payments. If you pass away before breaking even for checks you didn’t get, you end up receiving thousands less in Social Security over your lifetime.
2. Not understanding all the benefits you’re entitled to receive
Social Security provides more than just retirement benefits. There’s also a disability benefits program, as well as spousal and survivor benefits. If you don’t understand all that you’re entitled to, you could end up cheating yourself out of money you deserve.
For example, many people are forced to quit working early due to a health issue. While you might default to claiming retirement benefits if this happens to you, filing for Social Security Disability Insurance could be a better approach if you haven’t yet reached full retirement age. If you can get SSDI instead of retirement benefits, you can avoid early filing penalties that would otherwise reduce your monthly income.
This is just one example of how a failure to understand all of your potential benefits could cost you. You’ll also want to know the rules for spousal and survivor benefits, which you can receive based on a partner’s work history. These benefits are available even after a divorce, as long as your marriage lasted a minimum of 10 years.
You can’t always count on the Social Security Administration to explain all your options or advise you on the best strategy for optimizing your income, so do your own independent research to avoid leaving money on the table.
3. Making too much money as a retiree
Social Security benefits could also be lost to your state government or to the federal government. This can happen if your earnings are high enough that benefits become subject to tax.
State taxes on benefits apply only in 12 states. If you live in one of them, you’ll need to know the rules for when taxes are assessed on your retirement income. These are the 12 states where you could find yourself with a smaller check after state taxes have been paid::
- New Mexico
- Rhode Island
- West Virginia
Taxes may also be owed to the IRS if your countable income exceeds a certain threshold. Countable income is all your taxable income, MUNI bond interest and certain other non-taxed income, and one-half of Social Security income you’re receiving.
If income from those countable sources exceeds $25,000 for single tax filers or $32,000 for married joint filers, then between 50% and 85% of benefits is subject to taxation.
You can reduce the likelihood of losing Social Security benefits to taxes by choosing your retirement state wisely and/or by investing in a Roth IRA or 401(k) as distributions from Roth accounts are not part of your countable income.
4. Working while collecting benefits
Finally, earning too much income prior to full retirement age can also result in a loss of Social Security benefits, although this reduction in retirement income can be temporary.
If you will not reach full retirement age at all during the year when you’re working, you forfeit $1 in Social Security benefits for every $2 earned above $19,560 per year. If you will reach full retirement age at some point during the year but have not yet done so, you lose $1 in benefits for every $3 in earnings exceeding $51,960.
When you lose benefits due to working while collecting them, your benefits will be recalculated at full retirement age and checks will increase accordingly. So this reduction in benefits is temporary — provided you live long enough for the higher future payments to make up for missed income.
Understanding how and when your benefits could be reduced is crucial to guide decisions you make about Social Security, so be sure to take these issues into account as you make choices when approaching retirement.
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