The importance of Social Security for our nation's retired workers and their dependents cannot be overstated. The December update from the Social Security Administration found that 48% of all elderly couples and 71% of elderly individuals rely on Social Security benefits to provide at least half of their monthly income during retirement. This is pretty consistent with Gallup's findings that 59% of retirees count on Social Security to be their primary source of income.
But as a whole, the Social Security program isn't very well understood, which could mean that seniors are leaving money on the table because they weren't familiar with certain rules and aspects of the program. A 2015 joint survey conducted by the Financial Planning Association and AARP found that 9% of respondents believed they were "very knowledgeable" when it came to Social Security. However, when certified financial planners were questioned, just 1% (yes, one percent) said their clients were "very knowledgeable" when it came to Social Security.
Social Security rules to live by
With this in mind, here are four Social Security rules that'll help you get the most out of this critical program.
1. If you can wait, wait
One of the most important Social Security rules is: If you can wait, wait! The longer you wait to claim Social Security benefits (up to a point), the more your benefits will grow in size.
Seniors are eligible to begin taking Social Security at age 62, assuming they have enough work credits to qualify. However, taking Social Security benefits at age 62 means accepting a lifelong reduction in monthly payments. The most important number a senior should know is the age at which they'll hit their full retirement age, or FRA. A person's FRA is a dynamic number based on the year they were born, and it determines the point at which they become eligible to receive their primary insurance amount, which is considered their "full" monthly benefit. Right now the FRA is 66 years of age, but for those born in 1960 or later, it'll be 67 years.
Anyone who signs up for Social Security benefits before their FRA will get less than 100% of the benefits they're entitled to. However, if you file for benefits after reaching your FRA, then you'll receive more than 100% of your primary insurance amount, up until age 70, when benefits stop growing. Each year that you wait allows your benefits to grow by about 8%.
As an example, let's say a baby boomer born in 1954 files for benefits in 2016 at age 62. Their FRA is 66, so they claimed four years early, and thus they will receive 75% of their primary insurance amount each month for the rest of their life. In contrast, if this same individual waited until age 70 to claim benefits, then he or she would receive 132% of their FRA.
As of June 2016, the average retired worker's benefit was $1,348.49 a month. Assuming an FRA of 66 years, if the average retiree claimed at age 62 (the most popular age at which to file), you'd receive just $1,011 a month. If they instead waited until age 70 (which only around 3% of seniors do), then their payout would rise to $1,780 per month. That's a big difference, so it pays to wait as long as you can to claim Social Security benefits.
2. Don't count on Social Security as your primary source of income
However, just because waiting pays more doesn't mean you should rely on Social Security to be the sole source of your income.
The Social Security Administration says your benefit income is designed to replace about 40% of your working wages. (The percentage is higher for lower-income Americans and lower for well-to-do persons.) However, more than half of all Social Security recipients count on Social Security as their primary income source.
There are a couple of problems with leaning heavily on Social Security. For one, it's unlikely to provide enough income to allow you maintain your pre-retirement lifestyle. Secondly, the program is on shaky financial ground, at least over the long run. The latest report from the Social Security Board of Trustees forecasts that the Old-Age, Survivors, and Disability Insurance Trust, which pays benefits to 60 million-plus beneficiaries each month, will burn through its spare cash by 2034.
The great news is that this doesn't mean Social Security is going bankrupt. However, more revenue is needed to sustain current benefit levels, otherwise benefits may be cut by 21%. If you take Social Security before your FRA, or if you depend on Social Security income to make ends meet, could you withstand a 21% cut to your benefits? I'd guess not.
So you'll want to have other income vehicles in place to supplement Social Security in retirement. These could be tax-deferred investments accounts like a traditional IRA or employer-sponsored 401(k), or a tax-free investment tool like a Roth IRA. Regardless of which investment tool(s) you choose, make sure you have a plan B at the ready.
3. It probably isn't just about you
Although deciding when to file is an important personal decision, it could be just as important for your spouse or family.
For example, couples that have a large disparity in lifetime earnings can benefit from a little planning. If a higher-income spouse claimed benefits early, he or she could be hurting their lower-income spouse or children if they pass away. Survivor benefits, just like your own benefits, are affected by when you file for Social Security, so filing early could prevent a lower-income spouse, or your children, from collecting a substantial survivor benefit.
One of the smarter moves to make in these situations is to have the lower-income spouse file for benefits early in order to generate immediate income for the household. Meanwhile, the higher-income spouse can hold off on signing up, allowing their benefit to grow. Having the higher-earning spouse claim later will have a bigger positive impact on the higher-income spouse's benefit and the couple as a whole, and it will also provide some insurance for the lower-income spouse and children by raising their potential survivor benefits.
4. Expect to be taxed on your benefits
Lastly, you should head into retirement knowing that you could pay tax on at least some of your Social Security benefits.
In 1983, Congress made an amendment to the Social Security program that allowed the Internal Revenue Service to tax up to 50% of beneficiaries' benefits if they were married filing jointly and earning more than $32,000 or if they were an individual earning more than $25,000. In 1993, another amendment was added that boosted the taxability of Social Security income to 85% of benefits if the beneficiaries' annual income exceeded $34,000 for individuals or $44,000 for joint filers.
When initiated in 1983, these tax laws were only expected to affect about 10% of the population. However, it's been 33 years, and Congress hasn't adjusted these tax thresholds for inflation -- not even once! The result, per The Senior Citizens League, is that more than half of Social Security recipients will be taxed on at least some percentage of their benefits.
Opening up and contributing to a Roth IRA can potentially reduce your taxable income during retirement, as distributions from a Roth don't count as income. However, it can be pretty tough to keep your income below the thresholds of $25,000 for individuals and $34,000 for couples. So be prepared to surrender at least some of your benefits to Uncle Sam.