Until the Social Security Act was passed by Congress 83 years ago, financial support for the elderly consisted of employment, individual savings, family, local tax-supported programs, and corporate pensions or state-based programs. Sadly, those solutions were inadequate. State programs were limited, pensions weren't widely offered, jobs were hard to come by for seniors, and because most jobs were in the city, urbanization made family support a challenge.
Today, the risk of seniors falling into poverty is significantly lower than in the past because of guaranteed income from Social Security, but obstacles to financial security still exist that make maximizing Social Security benefits important. Here are three strategies for making the most of your Social Security income.
1. Work at least 35 years
The amount you'll receive in Social Security benefits at your full retirement age is based upon your average monthly income during your 35 highest-earning years, adjusted lower at specific income thresholds called bend points.
If you work fewer than 35 years, Social Security will use zeros in its calculation for those years without earnings, significantly reducing your benefit amount. For example, someone with inflation-adjusted annual income of $40,000 over the entirety of their 35 years earned an average $3,333 per month. However, if their career only included 25 years at $40,000, then zeros for the remaining 10 years would lower their average monthly income over 35 years to $2,381.
That's a big difference. And since that average income, after adjusting for bend points, determines what you can get in benefits at full retirement age, making sure you have 35 years of work history on your record is key to securing the biggest possible payment in retirement.
2. Delay the higher-earners benefit as long as possible
Social Security reduces benefits if you claim them prior to full retirement age, but if you wait to claim them, then they'll increase your benefit by the equivalent of 8% annually until you reach age 70. Those increases can result in a much bigger monthly benefit. For example, someone with a full retirement age of 66 who waits to claim until age 70 would pocket 132% of the amount they'd otherwise receive at age 66.
Since the increase awarded by credits is a percentage of income, the benefit of delaying is greatest for the higher-income spouse. Therefore, if you want to claim at least some benefits prior to age 70, it makes the most sense to claim the lower-earning spouse's benefit first and then hold off on the higher-earning spouse's benefit as long as possible.
Delaying the higher-earning spouse's benefit has another important consequence too. It also locks in the biggest benefit for a surviving spouse. Widows and widowers can only collect the higher of either their own benefit or their spouse's benefit, so waiting to lock in delayed retirement credits on the higher-earning spouse guarantees the surviving spouse the highest monthly payment, regardless of who passes away first.
3. Embrace a Roth IRA
Many Social Security recipients claim their benefits early only to be surprised by Social Security's earnings test, which limits how much recipients who are younger than full retirement age can earn without triggering a withholding of their benefits.
If you're younger than full retirement age, Social Security will hold back $1 in benefits for every $2 earned above $17,640 in 2019. A separate withholding rule applies for the year in which someone turns their full retirement age. If you turn full retirement age in 2019, you can earn up to $46,920 in the months leading up to your birthday. If your income is higher than that in those months, Social Security will withhold $1 for every $3 earned above that cap.
To prevent yourself from failing the earnings test and being subject to withholding, it can pay off to have funded a Roth IRA during your career. Roth IRA contributions are made with after-tax earnings, so withdrawals of Roth IRA contributions in retirement aren't subject to income tax, and they won't count against you in the earnings test. If your Roth IRA has been open five years and you're 59.5 years old, earnings on contributions can be withdrawn tax free too.
Tapping a Roth IRA to keep your earnings from work below limits may also reduce your federal income tax bill, because if you're single or married filing jointly, at least some of your Social Security will be taxed if your earnings exceed $25,000 and $32,000, respectively. Since the Internal Revenue Service doesn't count Roth IRA deductions as income, withdrawing money to reduce earnings from work could keep your Social Security from becoming subject to income tax.
Everyone's situation is different, but making sure you've worked 35 years, delaying the higher-earners benefit, and using a Roth IRA to stay below earnings limits could be key to making the most of your Social Security benefits and maintaining financial independence throughout your golden years.