Social Security, the program designed to provide a financial foundation for retired workers, survivors of deceased workers, and the disabled, is probably far more important than you realize.
According to the Social Security Fact Sheet released in June 2015, Social Security benefits represent about 39% of the average senior's income. Furthermore, 53% of elderly married couples and 74% of elderly unmarried persons count on Social Security benefits to provide at least half of their monthly income. This data makes it easy to understand why nine in 10 retirees told Gallup in Oct. 2015 that they rely on Social Security to help them meet their month-to-month expenses.
But the long-term health of this vital program is in jeopardy. The mass retirement of baby boomers, who are starting to become Social Security recipients themselves, is beginning to strain the program. There aren't enough younger American workers paying into the system to make up for the growing number of beneficiaries: The worker-to-beneficiary ratio is expected to fall to 2.1-to-1 by 2035 from 2.8-to-1 in 2015. We're also living longer, which is a great thing for retirees, but a bad thing for a program that will have to pay those retirees decades' worth of checks.
According to the Social Security Board of Trustees, the Old-Age, Survivors and Disability Insurance Trust is on pace to burn through its excess cash reserves by 2034. Should Congress fail to enact new laws that boost tax revenue or reduce benefits, the board has suggested that benefit cuts of up to 21% may be needed to extend benefit payments for another 55 years.
The three "W's" to a higher Social Security benefit
This means seniors, pre-retirees, and workers need to understand what it takes to get the most out of their monthly Social Security benefit. Thankfully, there are three "W's" that can guide us to a higher Social Security payment: wages, work history, and waiting.
The easiest way to net a bigger Social Security payment is to make more money throughout your lifetime. The Social Security Administration uses your average earnings over a 35-year period to calculate your monthly benefit at full retirement age, which for today's pre-retirees ranges between 66 and 67 years.
How do you earn more? Two of the most effective ways are to focus on a career path that's expected to see strong demand over the coming years and to earn at least a bachelor's degree. The latter path is often preferable, as it should give you more opportunity for socioeconomic advancement.
In 2014, Pew Research Center put out a study showing that millennials aged 25 to 32 with only a high school diploma earned a median of $28,000 per year (based on 2012 dollars). However, millennials of the same age with a bachelor's degree or more were taking home a median of $45,500 per year. A college degree can go a long way toward boosting your average annual income -- and thereby lifting your Social Security benefit in retirement.
As noted above, what you earn plays an important role in calculating your Social Security benefit. However, the other component concerns how long you work. The SSA averages your 35 highest-earning years to derive an average annual income that will be used to determine your monthly payment.
But what if you don't work at least 35 years? According to the SSA, for each year of zero earned income on your work history, a $0 will be factored into your income average, thus reducing your expected Social Security benefit during retirement.
It's also worth mentioning here that you need 40 lifetime work credits to qualify for Social Security benefits, and a maximum of four work credits can be earned per year. Each "work credit" equates to $1,260 in earned income in 2016, meaning that if you even worked part-time for 10 years, you'd likely qualify.
What this means is that you should work for at least 35 years in order to avoid getting any zeroes averaged into your benefit payment. Additionally, you might consider working into your mid to late 60s if you have the potential to earn a good wage. Replacing a lower-wage year with a higher-wage year would (modestly) boost your Social Security benefit.
The last "W" stands for waiting. Seniors have the option of filing for Social Security benefits as soon as age 62 -- and about 45% of eligible beneficiaries choose to do so. However, for each year that you hold off on claiming benefits, your eventual payment grows by about 8%, with age 70 being the point where your benefit maxes out.
It's worth noting that your eventual benefit check is a direct reflection of your full retirement age (FRA), or the age at which you're entitled to receive 100% of your benefit. If you file for benefits prior to your FRA, your monthly payment will be some figure ranging between 75% and 99% of FRA if you're born between 1943 and 1954. However, if you wait until after your FRA, your benefit can grow to as much as 132% of your FRA by age 70. So if you want the biggest benefit available to you, then waiting to file until age 70 is the answer.
Bear in mind, however, that Social Security is designed to pay you roughly the same total lifetime benefits no matter when you file. If you file early, you'll get smaller checks, but you'll get more of them. If you delay benefits, you'll get fewer checks over your lifetime, but they'll be larger. So you should carefully consider which option makes the most sense for you based on your finances, your longevity, and your plans for your retirement income.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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