Social Security is a progressive system, which means that it's intended to replace a greater portion of income for lower-income Americans than for those who earn more. That serves the purpose of helping those who have the least financial resources to save toward their own retirement. Yet even with its progressive design, Social Security doesn't replace all of a low-income retiree's wages and salary, which means most Americans need other sources of income to get by in retirement. Let's look more closely at how much someone earning $20,000 per year can expect to receive from Social Security.
What Social Security taxes cost low-income earners
Workers who earn $20,000 per year are well below the wage base limit for Social Security, which is more than six times that amount in 2017. That means these workers have payroll taxes withheld on all of their income. The amount is 6.2% of their wages, or $1,240 per year. Your employer pays another $1,240 directly for their share of your Social Security payroll tax.
All of your earnings go toward your work history for purposes of calculating your benefit. Unless you worked in a state or local government job in which the employer didn't participate in the Social Security program, then you'll get credit for the full $20,000 earned.
What Social Security will give you
The size of your final Social Security check will depend on your entire work history, not just what you're making now. For instance, if you've always made $20,000 per year, then you'll get less from Social Security than you would if you earned a greater amount for a long period in the past. Your benefits are calculated based your entire career, and the Social Security Administration factors up to 35 top-earning years into its benefit formula.
For these purposes, let's assume that a person earned the inflation-adjusted equivalent of $20,000 throughout an entire career. That's too tidy to be realistic, but it gives you a good baseline from which you can make personal adjustments.
In this example, your average indexed monthly earnings (AIME) would be $1,667 per month. The SSA's benefit formula for someone retiring in 2017 takes 90% of the first $885 in monthly earnings and then adds in 32% of earnings between $885 and $5,336. If your AIME is $1,667, then here's how your benefit would be calculated:
90% of first $856 = $770.40
32% of the remaining $811 = $259.52
$770.40 + $259.52 = $1,029.92
Therefore, if you retire at full retirement age, which is 66 and two months for someone turning 62 next year, then you'll get about $1,030 as your monthly benefit.
Notice something important about the result. Social Security does a reasonably good job of replacing work income for low-income individuals. Low-income workers get more than three-fifths of the money they earned during their career in the form of Social Security benefits. That leaves a sizable income gap for them to fill, but it's better than the roughly 25% to 40% of pre-retirement income that Social Security will replace for middle-income and high-income individuals.
Also, a lot depends on when you claim your benefits. If you start getting payments at 62, then they'll be almost 26% smaller, at about $764 per month. Wait until age 70, and you'll get almost 31% more, with monthly benefits of about $1,346.
Finally, if you didn't work throughout your entire life, then your benefit will be lower -- but not necessarily as much lower as you would expect. If you earned $20,000 for half a career, then your average monthly earnings will be $833. In this case, your Social Security payment will be a full 90% of that amount, or almost $750 per month, if you retire at full retirement age. That's almost three-quarters of what you'd get from a full career of work at that pay rate.
Be smart about Social Security
Low-income individuals tend to have the least financial flexibility in retirement, and Social Security is often the only reliable income source a retiree has. By making the best possible choices on Social Security, you can take maximum advantage of the program and avoid mistakes that plague some retirees who don't spend as much time and effort considering the right strategy for themselves.
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