Social Security is undoubtedly one of the most important programs in U.S. history, since it helps to provide crucial support for seniors. Unfortunately, many people have misconceptions about what Social Security can do for them in retirement. Finding out the truth can come as a huge shock, and it can leave you financially unprepared for retirement if you've made your plans based on faulty assumptions.
To make sure this doesn't happen to you, learn the truth about these three shocking Social Security facts now, while you hopefully still have time to take action to shore up your retirement security.
1. Benefits are only designed to replace 40% of income
One of the biggest shocks many retirees face is finding out that their Social Security benefits aren't designed to provide sufficient income for their retirement -- and won't even come close to doing so.
In general, when you stop getting paychecks, you'll need enough income to replace about 80% of the money that you were getting from your employer. But Social Security checks aren't designed to provide that much. Instead you'll get around 40% of preretirement income from them, so you will need to get the rest of your money from other sources.
If you are expecting Social Security to cover more than that amount, you could be left with a serious shortfall. Avoid this mistake by anticipating you'll need your nest egg to replace 40% of what you were earning before leaving work and setting retirement goals accordingly.
2. You could lose as much as 30% of your standard benefit if you claim at 62
It also comes as a surprise to many retirees that claiming benefits early could profoundly reduce the income Social Security provides.
You're entitled to a standard benefit, or primary insurance amount (PIA), which is based on what you earned over your career. This standard benefit doesn't become available until you've reached full retirement age (FRA). Your birth year determines your FRA, and it's between ages 66 and four months and 67.
Every month you get a check before FRA will result in an early filing penalty. These penalties reduce the amount of your monthly checks for the remainder of your life. The penalties equal:
- 5/9 of 1% during each of the first 36 months you've claimed benefits early.
- 5/12 of 1% during any prior month before then.
These penalties add up quickly. If you retire at the age of 62 when your FRA isn't until 67, your standard benefit will shrink by a whopping 30%. This must be considered when deciding if you should start getting checks ASAP when you become eligible for them or if you should delay.
3. You could lose some of your benefits to taxes
Finally, many seniors don't realize that both the federal and state government could take a cut of their Social Security checks. It's natural to assume this money will be tax-free since it's an earned benefit and you're getting back money based on how much you've paid in over the course of your life. But that's not always the case.
Your state could tax your benefits if you live in one of 13 states. And the federal government will begin assessing taxes once your provisional income reaches $25,000 as a single tax filer or $32,000 as a married joint filer. Provisional income is half your Social Security benefits, some nontaxable income such as MUNI bond interest, and all of your taxable income.
Paying part of your benefit in taxes leaves you with less to live on. And if you're already receiving a check that's smaller than expected, this could only exacerbate your financial problems.
Knowing these facts in advance can help you to be better prepared for your later years, since you'll have a better idea of how much Social Security income you'll end up with -- and how much extra money you'll need to supplement it.