If you're a long way from retirement, knowing the ins and outs of Social Security might not seem particularly important. However, your Social Security benefits should play a key part in your retirement planning process -- and you can't factor in your Social Security benefits if you don't understand how they work. The result will be a retirement plan that's either overly optimistic or overly pessimistic. So here's a brief primer on Social Security and what you need to know about it to craft an intelligent retirement plan.
1. How Social Security calculates your benefits
Social Security benefits are based on your income during the 35 highest-earning years of your life (adjusting for inflation). These 35 income figures are averaged together to come up with your base benefit amount. If you had less than 35 years of earnings, then Social Security will add in enough years of $0 in income to bring you to 35. For example, if you worked for 32 years and then retired, Social Security would add up the weighted earnings from those 32 years, add in three zero-earning years, and average the lot together. Thus, working less than 35 years can wreck havoc on your benefits checks.
2. What your "full retirement age" will be
Social Security's "full retirement age" -- the age at which American workers are eligible to receive their full retirement benefits -- used to be 65 for everyone. However, over the years, Social Security has moved its full retirement age up to account for the fact that people are living longer and longer. If you were born between 1943 and 1954, your full retirement age is 66. If you were born between 1955 and 1959, then your full retirement age is somewhere between 66 and two months and 66 and 10 months (for example, someone born in 1957 has a full retirement age of 66 and six months). And if you were born in 1960 or later, your full retirement age is 67.
3. How your retirement date affects your Social Security benefits
You can start receiving Social Security retirement benefits as early as age 62, but getting the money before your full retirement age comes at a cost. If your full retirement age is 67 and you start getting benefits at age 62, your benefits will be permanently reduced by 30%. Claiming Social Security at age 64 instead reduces your benefits by 20%, and claiming at 66 reduces your benefits by about 6.7%. On the other hand, if you wait until after full retirement age to start claiming Social Security benefits, you'll get delayed-retirement credits that will permanently increase your benefits by 8% per year you delay up to age 70. The Social Security website has a calculator you can use to see just how your chosen retirement date will affect your benefits.
4. How marriage affects your Social Security benefits
If your lifetime earnings have been quite low, you might assume that your Social Security benefits will be minuscule. However, if you're married to someone who brings home a fat paycheck, you may be eligible for an impressive spousal benefit from Social Security. In brief, when you apply for retirement benefits, the Social Security administration will compare the amount you'd receive based on your own earnings to the amount you'd receive as a spousal benefit based on your spouse's earnings. Then the SSA will pay you whichever benefit amount is larger. Spousal benefits can be as much as one-half your spouse's benefit amount, depending on when each of you started claiming Social Security.
5. How to estimate your Social Security benefit
The Social Security Administration provides a statement, both by mail and online, that lists your estimated benefits based on various potential retirement ages. Its website also has an Estimator Tool that you can use to see your expected benefit based on your last year's wages. However, if you're still a long way from retirement, these numbers will be pretty unreliable. Social Security doesn't know at this point what your wages will be from now until you retire (and neither do you, presumably). It will guess at your benefit amount based on what you've earned so far. Thus, if you have 10 or more years to go before you file for benefits, take this estimate with a big grain of salt. The closer you get to retirement, the more realistic your estimated benefit amount will get.
How to use this information in retirement planning
If you're decades from retirement, a lot could change before you start claiming Social Security benefits. Your earnings could go up or down, and because Social Security is running low on funds, the rules about benefits may change for the worse in the near future. What you can do now, however, is use this information to plan the optimal retirement date for your benefits. For example, it's important to have at least 35 years of wages behind you to max out your benefits, so that alone may affect your retirement date of choice. And claiming benefits before full retirement age obviously has some serious potential pitfalls.
The safest course of action is to save enough for retirement so that you will have sufficient income to cover your expenses without Social Security. That way, no matter what happens to the program, you'll be able to get by in retirement. Your Social Security benefits will be icing on the cake, and you'll have a much lower risk of running out of money after you retire.