Social Security can be a lifeline for many retirees, particularly if your savings are falling short. Roughly half of baby boomers say they expect Social Security benefits to be their primary source of income in retirement according to a survey from American Advisors Group, and about one in five married couples depends on their benefits for at least 90% of their retirement income according to the Social Security Administration.
Because Social Security benefits are a key component to many Americans' retirement, it's crucial to understand at least the basics of how the program works. However, the vast majority of workers can't answer this simple Social Security question.
What factors influence your benefit amount?
There are four factors that contribute to the amount you receive in Social Security benefits, yet just 9% of not-yet-retired workers over the age of 50 can correctly name those factors according to a survey from the Nationwide Retirement Institute.
Among those who are already retired the numbers are even more dismal. Around 8% of those who have retired recently can name the factors that impact their benefit amount, and just 7% of those who have been retired for at least 10 years can do so.
These four factors include your work history, age, the date you begin claiming benefits, and your marital status. Less than half of workers and retirees realized that the date they start claiming benefits affected how much they receive, and only 15% of workers understood that marital status can also affect their benefits. Furthermore, some survey respondents also mistakenly believed factors such as life expectancy and family medical history affect how much they'll receive each month.
Why is it important to understand how these factors impact what you'll receive in Social Security benefits? Because if you don't, you may end up receiving less than you expected. And if you're going to be relying on this money as a main source of income in retirement, you'll want to make sure you're earning as much as possible.
Social Security benefits: Behind the scenes
There are a lot of complex calculations that go into determining your exact benefit amount. While you don't need to understand exactly how these calculations work, it is important to at least understand the basics of how your benefits are determined.
First, let's look at work history. Your benefits are based on your 35 highest-earning years, so if you didn't work at least 35 years you'll have zeros in the calculation to account for the years you didn't earn any income. This brings your average down, which in turn lowers your basic benefit amount. If you haven't worked for a full 35 years and want to ensure you're earning as much as possible, you may choose to work a few years longer than you'd anticipated to increase your average and boost your benefit amount. Even if you have worked at least 35 years, you may still choose to work longer to replace some of your lower-earning years from early in your career with more recent higher-earning years.
Other factors that significantly impact your benefit amount are your full retirement age (FRA) and the age at which you begin claiming benefits. Your FRA is the age at which you'll receive 100% of the benefit amount you're entitled to. If you were born in 1960 or later, your FRA is age 67. For those born before 1960, your FRA is either 66 or 66 plus a few months, depending on what year you were born.
The earliest you can claim benefits is age 62, but by doing that you'll receive a reduction in benefits of up to 30% (if you have a FRA of 67). For every month you wait to claim past age 62, you'll receive slightly more money each month. If you delay claiming retirement benefits until after your FRA, you'll receive extra money on top of your full amount -- 24% extra, in fact, if your FRA is 67. The latest you can claim and still see an increase in benefits is age 70, though. So while you can still wait to claim benefits beyond age 70, you won't receive any extra each month by doing so.
An important thing to note is that these benefit amounts are essentially set in stone for the rest of your life (save for annual cost-of-living adjustments). You have one chance to change your mind after you claim, but it has to be within one year of claiming, and you have to pay back all the benefits you've already received. After that, you're stuck with your decision. So if you claim at age 62 and then decide a few years down the road you'd rather wait until 70, you're generally stuck with those smaller checks whether you like it or not.
Finally, marital status can also affect your benefits. Even if you've never worked a day in your life, if your spouse is entitled to Social Security benefits you can receive up to half of their full benefit amount (which won't affect how much your spouse receives). Keep in mind, however, that the same rules apply when it comes to claiming before your FRA, so if you claim early your benefits will still be reduced.
Maximizing your Social Security benefits
Once you know the basics of how your benefits are calculated, you can make educated decisions to maximize the amount you receive. You may work a few more years to increase your total earnings, for example, or delay claiming benefits past your FRA.
If you and your spouse are both eligible for benefits, work out a strategy to make the most of your combined amounts. For example, the lower-earning spouse may choose to claim early so that the two of you have some money to start spending now, then the higher-earning spouse can wait until their FRA or beyond to claim to earn those bigger checks for the rest of retirement.
Regardless of when you choose to claim your benefits, the key is to understand the factors that influence how much you'll receive. If you're going to be relying on your benefits for a significant portion of your retirement income, it pays to know how you could be maximizing your money.