Millions of Americans count on Social Security as a key source of retirement income, but because the program is fairly complex, it's easy to fall victim to a major mistake that could prove costly over time. Whether you're planning to retire in the near future or still have several working years to go, here are three common Social Security blunders you'll want to sidestep.
1. Claiming benefits early because you think the program is running out of money
It's true that Social Security is in a pretty precarious financial state. The program, which relies on incoming tax revenue, as well as its trust funds to pay beneficiaries, faces an $11 trillion shortfall once those trust funds run dry.
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But there are a few things you should know about Social Security's finances. First, as per the latest estimates, the trust funds won't run dry until 2034, which means we technically still have over a decade and a half to go before Congress really needs to implement a backup plan. Second, even if those funds run out and Congress doesn't step in with a solution, thanks to future incoming tax revenues, the program will still have enough money to pay out about 79% of scheduled benefits. Furthermore, all things being equal, the program will be capable of sustaining benefits at that level until at least 2090.
It's one thing to file for Social Security early because you need the money and don't have another source of income. But rushing to file at age 62 (the earliest age you can claim Social Security) because you're afraid the program will otherwise run out of money is a less prudent move. Claiming benefits before reaching your full retirement age (which for today's workers is 66, 67, or somewhere in between) will reduce your payments by 6.67% for the first three years and then 5% a year thereafter. Worse yet, that reduction will remain in effect for the rest of your life, so think long and hard before filing for benefits sooner than you actually need to.
2. Holding off on benefits when you have known health issues
Some people opt to delay Social Security past their full retirement age because doing so boosts benefits by 8% a year up until age 70. And while that's a strategy that could pay off if you live well into your 80s or 90s, it's likely to backfire if you end up dying sooner. The thing to remember about delayed benefit credits is that while they will increase your monthly payments, you'll also have fewer payments to collect. If you're thinking of postponing Social Security, you'll need to calculate your break-even age and do your best to determine whether or not you'll live past it.
Say your full retirement age is 66, at which point you'd be eligible for $1,500 a month in benefits. Waiting until age 70 to file for Social Security will boost each individual payment to $1,980, but you'll have 48 fewer payments to collect. Now in this example, your break-even age will be 82.5, because at that point you'll have collected a total of $297,000 in lifetime benefits under either scenario. If you think you'll live past 82.5, it might pay to hold off. But if you don't think you'll make it to 82.5, whether because of existing health problems or a family history of dying young, then waiting to collect benefits just doesn't make sense.
3. Assuming your benefits won't be taxed
You can -- and should -- factor Social Security into your ultimate retirement budget, and the Social Security Administration (SSA) makes it fairly easy to do so. All you need to do is enter some personal information online, and the SSA will estimate your benefit payments for you. But once you have that amount, don't make the mistake of assuming you'll actually get to pocket it in full. While some Social Security recipients get to collect their payments free and clear of taxes, if you have other income sources, your benefits may be partially taxed.
To see whether this scenario applies to you, you'll need to calculate what's known as your provisional income, which is your non-Social Security income (including tax-exempt interest) plus half of your annual benefit amount. If your total falls between $25,000 and $34,000 as a single tax filer, or between $32,000 and $44,000 as a couple filing jointly, you could be taxed on up to 50% of your benefits. And if your total exceeds $34,000 as a single filer or $44,000 as a couple filing jointly, you could be taxed on up to 85% of your benefits.
In addition to federal taxes, you might also pay state tax on your benefits depending on where you reside. There are currently 13 states that tax Social Security to varying degrees:
- Colorado
- Connecticut
- Kansas
- Minnesota
- Missouri
- Montana
- Nebraska
- New Mexico
- North Dakota
- Rhode Island
- Utah
- Vermont
- West Virginia
Now the good news is that most of these states offer some form of exemption, so if you're not a particularly high earner as a senior, you can probably avoid state taxes -- at least in part. But don't forget to take taxes into account when creating a retirement budget, or it could wreak major havoc on your financial plans.
The rules surrounding Social Security can be somewhat tricky to navigate, so it pays to educate yourself on how the program works before making any moves. The more thought you put into collecting those benefits, the more you stand to gain in the long run.
