For many seniors, Social Security makes retirement possible. But while benefits help sustain you, it’s important to have a realistic idea of how far they’ll go and how decisions you make impact the support they offer.
It’s difficult to change course after claiming Social Security, so before you retire there are five facts you must know to make informed choices.
1. Your benefit is designed to replace only around 40% of pre-retirement income
Most experts recommend replacing at least 80% of pre-retirement earnings when you stop working. This enables you to avoid a drastic reduction in quality of life and to afford new costs, including increased healthcare expenditures.
Social Security isn’t designed to do that. Benefits were meant to work in conjunction with savings and a pension. As a result, Social Security is meant to replace around 40% of pre-retirement income for most older Americans and even less for high earners.
If you anticipate your retirement payments will cover all your costs, or even most of them, you could make a misinformed choice about your retirement readiness. Struggling to live on Social Security alone could put you near the poverty level and make life very difficult.
2. Your age when you start benefits affects the income they provide
Many retirees are unaware of the profound impact their Social Security claiming strategy can have on the income their benefits offer.
Retirees receive a standard benefit based on their average wages. But seniors get this amount only if their first check is claimed at full retirement age. Your designated FRA is based on birth year and is:
- 66 and four months if you were born in 1956
- 66 and six months if you were born in 1957
- 66 and eight months if you were born in 1958
- 66 and 10 months if you were born in 1959
- 67 if you were born in 1960 or later.
For each month benefits are claimed prior to FRA, they’re reduced. And for each month after FRA that no benefits are received, they’re increased. Here’s how this works:
- A penalty of 5/9 of 1% applies for each of the first 36 months benefits are received before FRA. Annually, this adds up to a 6.7% reduction
- An additional monthly penalty of 5/12 of 1% is applied when benefits are claimed more than 36 months before FRA. The annual reduction adds up to 5%.
- A delayed retirement credit of ⅔ of 1% applies for each month between FRA and 70 that benefits are delayed. This adds up to an 8% annual increase
Because of these penalties and credits, a person who starts their checks five years before FRA would see their standard benefit reduced by 30% while someone who waits for three years after would see it increased by 24%. The change affects monthly benefits for life.
3. Your decisions about your benefits could affect your spouse
Married couples must coordinate on when to claim benefits as spousal and survivor benefits are impacted by choices each person makes.
Spousal benefits are available to those who are married or divorced after 10 years. They could add up to as much as 50% of the primary earner’s benefit at full retirement age. However, spousal benefits aren’t available until the primary earner starts their checks. In some cases, it makes sense for the higher earner to claim benefits ASAP to unlock spousal benefits. This is often a good approach when one spouse doesn’t qualify for their own benefits because they didn’t work long enough.
However, survivor benefits also must be considered. These are also available to people who are married or divorced after at least 10 years. They allow the last surviving spouse to receive the higher of the two benefits either person was receiving. If the higher earner had a reduced check due to early filing, his widow would be left with less.
To enable a higher earner to maximize survivor benefits, it can make sense for the spouse who earned less to claim their retirement benefits early to provide essential income. This enables their partner to delay, raise their monthly benefit, and increase income from survivor benefits after a death.
4. Working while collecting benefits could pose problems
You don’t have to give up work to claim Social Security. However, if you haven’t reached full retirement age, earning income could reduce your benefits.
In 2022, you lose $1 in benefits for each $2 earned above $19,560 per year or $1,630 per month if working during a year when you won’t reach FRA at all. And you lose $1 for each $3 earned above $51,960 per year or $4,330 per month if working before FRA but you’ll hit that milestone sometime during the year.
When benefits are forfeited, entire checks are withheld. A retiree receiving a $1,500 monthly check who forfeits $3,000 in benefits wouldn’t receive checks for two full months. Upon reaching FRA, the months of missed checks are tallied up. You’re credited back early filing penalties that would’ve otherwise applied during those months.
While you eventually get back the missed money in the form of higher future benefits, you could still face problems if you hoped to get Social Security and a paycheck.
5. You may be taxed on the benefits you receive
Social Security benefits are sometimes subject to federal and state tax.
Up to 50% of benefits are taxed at the federal level for single filers with provisional income between $24,000 and $34,000 and up to 85% of benefits are taxed once provisional income climbs above $34,000. For married joint filers, up to 50% of benefits are taxed with a provisional income of $32,000 to $44,000 and up to 85% of benefits are taxed above this level.
Provisional income equals 50% of Social Security benefits plus income from a variety of other sources including wages; pensions; annuities; investment returns; dividends; and interest from tax-exempt bonds. Since the tax thresholds aren’t indexed to inflation, more retirees each year pay federal taxes.
States have their own rules regarding benefit taxation as well. If you live in one of these 13 locations, you’ll need to learn local rules as benefits are taxed under some circumstances:
- New Mexico
- North Dakota
- Rhode Island
- West Virginia
Ultimately, knowing what impacts your monthly benefit — and what your Social Security checks will actually do to support you — is crucial to making the right choices about retirement. Be sure you know these facts to avoid making a decision you regret.
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