Even though Social Security accounts for more half of retirement income for 71% of single retirees, many Americans don't fully understand how it works or have the time to learn everything about it. While there's a lot to know about Social Security, here are five facts that every person should be aware of.
No. 1: It won't go bankrupt, but cuts are looming
Social Security is a pay-as-you-go program, and that makes it very different from the retirement plans you contribute to at work. Your payroll tax payments aren't set aside for your retirement; they're paid out to current Social Security recipients.
The good news is that this means that as long as Americans are working, and payroll taxes are being collected, Social Security will have at least some money to pay you.
The bad news, however, is that Social Security's paying out more to retirees than it's receiving in taxes, and that's forcing it to tap a trust fund to make up the difference. This trust fund is expected to run out of money in 2034, and at that point, Social Security will have to be cut across the board by about 25% so that payments match payroll tax revenue.
No. 2: People qualify after 10 years of work, with exceptions
To qualify for Social Security, you need to accumulate 40 work credits. Typically, that works out to 10 years of working and paying taxes.
You don't necessarily have to work 10 years, though. Widows and widowers, for example, can receive survivor's benefits based on their spouse's work history. Similarly, unmarried singles can receive benefits based on their ex-spouse's work history, if they were married 10 years and their spousal benefits exceed the benefits they would receive otherwise. Don't worry: This doesn't reduce your ex-spouse's Social Security payment.
No. 3: Social Security income varies widely
You may have heard that Social Security replaces 40% of your pre-retirement income, but while that's true for the average worker, it won't be true for everyone.
Social Security calculates your benefits by adjusting your highest 35 years of monthly income for inflation and then averaging them. It then applies "bend points" to that average to reduce it. For instance, if you were born in or after 1954, then you would get credit for 90% of your average monthly income up to $895, 32% of any income between $885 and $5,397, and 15% of income above $5,397 in 2018.
These bend points mean that people with lower average monthly income will have a larger proportion of their income replaced than people with higher average monthly income. If you're curious, you can find out your specific benefit amount by logging in to Social Security's website.
No. 4: You can claim early, late, or anywhere in between
You can begin receiving Social Security payments at any point after reaching age 62. However, the amount you collect in benefits per month depends on if you claim before or after reaching your full retirement age.
Your full retirement age is the age at which you qualify for 100% of your benefit amount, and it depends on your birth year. In 2018, full retirement age is 66 and four months, but that will increase by two months per year until it reaches age 67 for people born in or after 1960.
If you claim benefits early, your monthly benefit will be reduced by five-ninths of 1% per month for the first 36 months and five-twelfths of 1% for each additional month that you claim before full retirement age. For instance, people who were born in 1956 and who claim at age 62 would have their benefit reduced by 26.67%.
If you wait to collect benefits until after your full retirement age, Social Security will reward you with delayed retirement credits that increase your benefit by two-thirds of 1% for every month you hold off claiming. You can collect these credits up until age 70, and overall, the monthly increase works out to about an 8% increase per year, if you were born after 1943.
No. 5: Social Security can be reduced, and you might pay taxes on it
If you claim Social Security before your full retirement age, you can only earn up to $16,920 from work in 2018 without having it reduce your monthly benefit. Social Security will hold back $1 for every $2 you earn above that amount. The rule's a bit different for the year in which you do turn your full retirement age. In that year, you can earn up to $44,880 before beginning to receive your full retirement benefit without having it reduce your payment. If you earn more than that, then $1 for every $3 will be held back.
Don't worry, though. You won't lose any money that's withheld. Instead, it will be added back to your calculation and thus increase your benefit when you do reach full retirement age. Also, don't worry about this earnings test if you're older than your full retirement age. You can earn as much as you want without having it lower your payment.
Taxes, however, are another story. The IRS will make you pay taxes on Social Security if your combined or provisional income (recipient's gross income, tax-free interest, and 50% of Social Security benefits) is above limits.
The good news is no one pays taxes on more than 85% of one's Social Security income. The bad news is that if you're single and your provisional income exceeds $25,000, or you're married and your provisional income exceeds $32,000, you'll have to pay taxes on at least some of your Social Security income.
These five facts are important, but they're far from the only things you'll want to know about Social Security. For instance, strategies can increase your benefit payment, so it may be worth learning as much as you can.