Social Security provides income to about 90% of seniors in the U.S., and is the primary source of income for about half of married couples and close to three-quarters of unmarried seniors.
Since your Social Security benefits are likely essential to supporting yourself in retirement, it's important to understand exactly how Social Security works. Here are three key facts you need to know so you can understand when to claim your benefits and how much you'll receive in income.
1. Your benefits could be taxed
When you're receiving Social Security as a senior, you may owe taxes on benefits. This could include state and federal taxes, depending where you live.
If your income is above $25,000 and you file taxes as single or $32,000 as a married couple filing jointly, you'll have to pay federal tax on 50% of benefits. If you earn more than $34,000 as a single person or $44,000 as a married couple, 85% of benefits are taxable. However, only certain income counts in determining if you'll be taxed.
Income includes half of Social Security benefits and half of other taxable income. Some tax-free income, such as interest from municipal bonds, counts as income, but distributions from Roth retirement accounts don't. If you're single and earn $20,000 in Social Security and $6,000 in investment income, you wouldn't be taxed.
It's important to be strategic about withdrawals from retirement accounts because of tax implications. Taking money out of a 401(k) or IRA can boost taxable income such that Social Security benefits become taxable. If you can, keep withdrawals low enough to avoid triggering taxes -- and if you can't, withdraw enough to cover your bigger tax bill.
You may also wish to convert some retirement income to a Roth account, which allows tax-free withdrawals. There's rules to follow and taxes to pay when you make the conversion, but you won't have to worry in the future about withdrawals triggering taxes on Social Security.
If you live in one of the 13 states that tax Social Security, you may also have state income taxes to pay. If you're struggling, moving to a state where Social Security is tax-free may make sense.
2. Working could reduce your benefits
If you work while receiving Social Security, benefits could be reduced based on income if you're below full retirement age (FRA).
The Social Security Administration reduces benefits by $1 for each $2 earned above the annual limit if you're under full retirement age for the entire year that you're working. In 2018, the annual limit is $17,040. If you earn $30,000, benefits would be reduced by $6,480 ($30,000 - $17,040 / $2).
If you're working in the year you'll reach FRA, the rules are different. You'll have just $1 in benefits deducted for every $3 earned above a much higher limit. In 2018, the limit is $45,360. The SSA also only counts earnings before the months you reach FRA. If you turn 66 in June and 66 is your FRA, the Social Security Administration only counts earnings from January through May.
If benefits are reduced because you work before FRA, this reduction can lead to a higher benefit later in life. Before you decide to take a job, consider how Social Security will be affected now and in the future.
3. Your benefits are only supposed to replace about 40% of your income
Social Security benefits will replace around 40% of your preretirement income if you have average earnings during your career. Most estimates suggest you'll need to replace at least 70% of your income -- and perhaps much more -- to have a comfortable retirement.
If you don't have enough savings or a pension to provide income to supplement Social Security, you may wish to look into work opportunities. Alternatively, you'll need to budget very carefully to make your Social Security checks stretch further.
Moving to a lower cost of living area and cutting back on big expenses -- such as getting rid of your car -- could help you survive on benefits available to you.
Understanding Social Security is essential
As a senior, Social Security will almost assuredly make up a big portion of your income. By understanding how working and taxes affect your money -- and how far your money will go -- you can make the most informed choices about maximizing the benefits you may rely on.