Social Security: An Overview
I’ve been crafting this Social Security overview for the last 3 years. Seriously. It has taken me that long to get it to the level of thoroughness that I feel justifies the headline. The vast majority (99%+) of Social Security articles you will ever come across deal with when to start claiming your benefits. For example:
“When Should you Begin Claiming Social Security?”
“Why you Should Take Social Security as Early as Possible.”
“The ROI of Waiting Until Age 67 or Age 70 to Begin Claiming Social Security.”
These are important topics for many, but given the age demographic that follows this blog, hopefully you’re not interested in such matters quite yet. And if you are, it may be time to shut the computer and give your friends a call or take your dog for a walk. Besides, I have little to offer since I don’t yet care about those topics. Age-related Social Security optimization strategies will be important for you at some point – and if I’m still writing in 25 years, I promise a part II. ;-)
I’m going to take a different angle – one that you probably haven’t seen elsewhere: an overview of everything those under age 62 need to know about Society Security.
And, yes, there are a few absolutely essential things that everyone should know about Social Security that have nothing to do with age and claim optimizing. In fact, all the age claim optimizing are entirely dependent on these things. But nobody talks about them! That’s because just having “Social Security” in a headline is perceived to likely scare off anyone not close to the typical retirement age.
There’s also a lot of misinformation and scare stories about Social Security that has led to a severe knowledge deficit and lack of faith in it. As a result, Generation X (77% of Gen X, 77% of Gen Y (millennials), and 70% of Gen Z are concerned Social Security won’t be there for them for retirement. That’s not going to happen.
So, I’ve set out to address the myths and realities in this post. And much more. Here is what is covered in this Social Security article:
What is Social Security?
First off – a quick primer on what Social Security is. Social Security is a federal government run program that consists of a number of components, including Old Age insurance (OAI), disability insurance (DI), Medicare, and Medicaid.
Social Security taxes are deducted through your employer’s payroll, as required by the Federal Insurance Contributions Act (FICA). This is what funds Social Security and Medicare trusts.
For the purposes of this post, we’ll focus on the retirement component only – Old Age Insurance. Social Security retirement benefit payments amount to a defined benefit pension (aka a “pension”) – where you get a defined payout based on your taxed earnings when you reach retirement age. If you’re under age 50, Social Security is likely the only defined benefit pension that you’ll ever get.
Social Security is Essential for Most Americans. Here is Why.
Simply put: employers are letting us down and we are letting ourselves down when it comes to retirement. The retirement system available to Americans is being completely gutted and Social Security is often the only leg left standing for many – precisely because it is the only mandatory and automatic leg.
Defined benefit pensions are going extinct , after having been under attack for the last two decades. The Pension Benefit Guaranty Corp (PBGC) covers a portion of private pensions, but outside of those grandfathered in to a plan, there are very few private pensions that still exist today. Only 25% of workers in the U.S. have access to a defined benefit plan. Most of those are in the public sector – as 86% of state and local government workers still have access to defined benefit plans. Public sector pensions, which had been thought to be untouchable, have increasingly been open to attack, particularly in the follow-up to the Great Recession, when austerity ripped through city budget decision-making.
Meanwhile, only 61% of the population has access to a 401K or other defined contribution plan. And only 71% of those individuals participate in the plan offered to them. The promise of 401Ks replacing pensions has dramatically fallen short of reality.
What’s left? Social Security.
Among elderly Social Security beneficiaries, 50% of married couples and 71% of unmarried persons receive 50% or more of their income from Social Security. And that is from a generation that was showered with cushy pensions (as younger workers no longer are). As more and more of boomer population (who actually have access to guaranteed pensions) passes on, the reliance on Social Security income is going to dramatically increase for future generations. There is a legitimate claim to actually expand Social Security to meet this need, and that movement is growing louder, particularly within the Democratic Party.
Social Security’s Demise has Been Greatly Exaggerated, Particularly by Millennials
There has been a lot of “sky is falling” press and political discourse around Social Security in order to induce fear for benefit cuts. There is some legitimacy behind this that needs to be addressed. However, Social Security is not going away. And we should take a very calm and measured approach to any reform.
Here’s the reality: the retirement benefit portion of Social Security has a $2.75 trillion surplus of reserves at the moment.
Social Security is a defined benefit retirement program that is dependent on an inter-generational transfer of income. All things being equal, if a population stays consistent in numbers, the program is self-sufficient.
But, all things are not equal. The vast amount of baby boomers are going to deplete those reserves, just as they built them up throughout their working years. Once they pass on, things would be back to normal, if not for one other minor detail: Franken-bodies. The population is being kept alive longer through medical procedures and pills these days, and that changes things because payments continue from the age of claiming through end of life. At some point, in order to address this and keep Social Security fully self-funded for future generations, one or more of the following is going to have to happen:
- population growth in the United States exceeds estimates (via reproductive rates and/or documented immigration)
- there is a slight increase in the qualifying age for benefits
- there is a slight decrease in payment benefits
- there is an increase in the Social Security tax rate
- the cap on Social Security eligible taxable income is increased, removed (similar to Medicare), or made more progressive
Even if none of those things happens, Social Security is fully funded until 2034, with no changes. After the depletion of reserves (again, due largely to the vast amount of baby boomers getting older), continuing tax income would be sufficient to pay 77% of scheduled benefits in 2034 and decline to 72% in 2096 (when a 30 year-old today would hit age 104). And keep in mind that Social Security is projected to result in inflation-adjusted real rates of return that are positive for everyone and very positive for many, as the funds earn interest over time. We’re talking about scheduled benefit payouts, not contributions (half of which comes from your employer, by the way).
So, for just about everyone reading this article – you’re probably going to get a minimum of 72% of your scheduled benefit payouts, barring unforeseen circumstances. And you’ll get a healthy return versus what you personally contribute. With some minor changes, like a higher income cap, it could easily be back to 100% of scheduled benefits being paid out. And that’s a good thing. It’s in your best interests and the best interests of this nation for Social Security to not only survive, but be well funded for our lifetimes. Otherwise? Brain-eating elder franken-zombies roaming the streets that we’ll all have to pick up the tab for, one way or another.
There is Strong Support for Raising Social Security Benefits (Not Cutting Them)
Despite scaremongering attempts to discredit it, Americans overwhelmingly see the the value in Social Security, regardless of political affiliation. For starters, a comprehensive survey of Americans on Social Security had some interesting findings. It found that participants almost universally rely or think they will rely on Social Security,
Of respondents currently receiving Social Security, 95% say it is important to their monthly income; of those not currently receiving Social Security, 85% say it will be important to their income when they begin receiving benefits.
Not only that, but a large majority want to see benefits increased, not reduced (as raising the age limit would do),
86% believe that Social Security benefits do not provide enough income for retirees, and 72% believe we should consider increasing benefits in order to provide a more secure retirement for working Americans.
That includes 69% of millennials, by the way.
And participants were even willing to increase taxes to preserve Social Security:
77% agree that it is critical to preserve Social Security benefits for future generations, even if it means increasing Social Security taxes paid by working Americans, and 83% agree it is critical to preserve Social Security benefits for future generations, even if it means increasing taxes paid by top earners.
Still, It’s Best to Not Rely Entirely On Social Security
All this being said, Social Security was never intended to be the sole source of income for the elderly. From its creation, it was meant to primarily be a generational transfer crux for those who survived to an old enough age or to support widows of primary wage earners.
At most, Social Security should be looked at as a supplement to a well-funded retirement plan. It’s best to think of it as a hearty side to what is hopefully a delicious holiday feast – not the main entree. Living entirely off of Social Security, even after a career of higher earning levels, would result in a fairly impoverished state. Whether you get paid 74%, 90%, or 100% of expected benefits, it’s not going to be enough to thrive for most people.
What you Need to Know About Social Security Benefit Payments Now
Whether you like it or not, it’s best that you know what you’re dealing with here and how to get the most out of it.
How Much is the Social Security Tax Rate?
You currently pay a rate of 6.2% of your income and your employer also contributes 6.2% of your income.
What if you are Self-Employed?
If you are self-employed (not employed by another), you must pay the 6.2% employer half, as well as the 6.2% employee half of Social Security taxes on income. However, you only pay on net income (after expenses from doing business).
To help equalize things for self-employed individuals, only 92.35% of their self-employment income is subject to Social Security and Medicare Taxes. Additionally, self-employed taxpayers can claim an income tax deduction equal to the portion of the self-employment taxes that the employer would have paid when figuring their income taxes. You can claim this deduction as an adjustment to income, so you receive credit for it even if you don’t itemize deductions when you file.
Do you Have to Pay Social Security Taxes on Capital Gains, Dividends, or Interest?
You do not have to pay Social Security taxes on unearned income such as capital gains, dividends, and interest.
Social Security taxes are only required for earned income, i.e. wages, bonuses, or self-employed net income.
What About Social Security Taxes on Employee Stock Units or Options?
For most employee stock units and options, the IRS levies ordinary income, Social Security, and Medicare taxes on the difference between the fair market value when you exercise the stock units and the grant price.
What is the Maximum Amount you have to Pay in to Social Security?
In 2022, the maximum taxable earnings for Social Security is $147,000. There are annual cost of living (COLA) adjustments to this amount, which are tied to the Consumer Price Index, or CPI.
With a 6.2% taxable rate, the maximum dollar amount an employed would be required to pay in to Social Security in 2022 would be $9,114.
What is the Maximum Social Security Benefit?
The maximum Social Security benefit in 2022, per person, for a worker claiming at full retirement age, is $3,345 per month.
What is the Average Social Security Benefit?
The average Social Security benefit in 2022, per person, for all retired workers, is $1,461 per month. Breaking it down further in to example demographics, the averages are:
- All Retired Workers: $1,657/month
- Aged Couple, Both Receiving Benefits: $2,753/month
- Widowed Mother, and 2 Children: $3,187/month
- Aged Widow(er) Alone: $1,553/month
- Disabled Worker, Spouse, & One or More Children: $2,383/month
- All Disabled Workers: $1,358/month
How are Social Security Benefits Calculated?
Benefits are calculated based off of your Social Security taxable earnings, how many years you have worked, and the age that you start claiming benefits.
Social Security payments are based off of your top 35 years of taxable income. If you have 50 years of income, it’s based off the top 35. If you have 30 years of income, for example, the other five years will count as $0.
What are the Minimum Number of Years you Need to Work to Qualify for Social Security?
You have to have a minimum of 10 years of taxable income in order to receive any individually earned benefits, but there are income thresholds that you must pass in those years. You can earn a maximum of 4 “credits” per year and need 40 credits total in your working years in order to be eligible to receive Social Security benefits.
In 2022, for example, a credit is earned for each $1,510 of income (up to 4 credits, or $6,040).
At what Age can you Claim Social Security? What is the Impact of Delay?
I know that I said I wouldn’t cover this in this article – but a 1 paragraph basics primer on Social Security claiming and optimization wouldn’t hurt. You are eligible to begin claiming Social Security at age 62. Normal retirement age is considered to be age 67, for those born in 1960 and later (here’s a chart on full retirement age for those born earlier). And you can delay claiming up until age 70.
If you claim prior to age 67, your benefit payments may decline by up to 30% per year for the rest of your life. Benefits are reduced 5/9ths of 1% for each month before normal retirement age, up to 36 months. If the number of months exceeds 36, then the benefit is further reduced 5/12ths of 1% per month. For example, if the number of reduction months is 60 (the maximum number for retirement at 62 when normal retirement age is 67), then the benefit is reduced by 30%!
If you claim after the full retirement age of 67, benefits increase, and continue to do so up to age 70. Each year you delay adds an additional 8% to your payments (up to a 24% maximum credit for delaying).
How Do Social Security Spousal Benefits Work if you Don’t Work or are a Widow?
Social Security’s design includes valuable spousal benefit features that pay benefits to non-working spouses and surviving widows. Spouses are entitled to receive the greater of his/her own benefit or half of their spouse’s benefit. And surviving widows can step up to 100% of a deceased spouse’s benefit.
Where Can I See My Social Security Earnings & Projected Benefits?
You can get your Social Security statement online at ssa.gov., which will show your Social Security earnings history and projected benefits. A Social Security account is one of the few government accounts everyone should create as there are a number of helpful benefits to doing so. SSA currently only mails statements to workers age 60 and over who aren’t receiving Social Security benefits and do not yet have a “My Social Security account”.
Social Security Calculators
As noted, you can find your projected Social Security estimates online at ssa.gov. You can also have your numbers crunched through a variety of Social Security Calculators, depending on what you are trying to calculate. This Social Security calculator is the most commonly used version.
Social Security & Early Retirement
Social Security payouts are calculated using your average indexed monthly earnings (AIME). Your AIME is then used to calculate your primary insurance amount (PIA), which is the amount you will get if you claim Social Security at your full retirement age. Your 35 highest earning years will be totaled and averaged out to your AIME (including ZERO for years without earnings).
For 2022, PIA is the sum of:
- (a) 90 percent of the first $1,024 of his/her average indexed monthly earnings, plus
- (b) 32 percent of his/her average indexed monthly earnings over $1,024 and through $6,172, plus
- (c) 15 percent of his/her average indexed monthly earnings over $6,172.
These amounts will change in future years.
This can get complex, so plugging in your actual and projected earnings and retirement dates in to a Social Security early retirement calculator like this one, can be extremely helpful.
While the full funding of Social Security benefit payouts is in doubt, there are many ways that it can be filled, with a little political will. It is clear that a large majority of Americans want more Social Security, not less, and plan to rely on it heavily. Given the massive failure of 401Ks to fill the gap left behind with the decline in pensions, Social Security’s role in providing a financial safety net to those in their senior years is more important than ever.