Chances are, Social Security will end up serving as an important income source for you during retirement. But if you're not well-versed on the following points of information, your financial plans could end up getting thrown for a loop.
1. Social Security is taxable
If Social Security is your only income source during retirement, then you may not be liable for federal taxes on your benefits. Otherwise, you can expect to be taxed on those benefits to some degree, depending on your provisional income.
Your provisional income is your non-Social Security earnings plus 50% of your annual benefits. If it lands between $25,000 and $34,000 and you're a single tax filer, or between $32,000 to $44,000 and you're a married couple filing taxes jointly, then up to 50% of your Social Security benefits may be taxed. And if your provisional income exceeds $34,000 as a single tax filer or $44,000 as a joint filer, you could be taxed on up to 85% of your benefits.
Keep in mind, though, that these figures apply to federal taxes on your benefits. There are 13 states that impose their own taxes on Social Security income, as well:
- New Mexico
- North Dakota
- Rhode Island
- West Virginia
As such, you may want to plan to lose a portion of your Social Security benefits to taxes -- especially if you intend to retire in one of the above states.
2. Social Security won't fully replace your former earnings
Many seniors assume that Social Security will replace their former paychecks entirely. It won't.
If you're an average earner, your benefits will replace about 40% of your pre-retirement wages, but most seniors need about twice that much income to cover their expenses and maintain a decent lifestyle. As such, don't assume you'll get by in retirement on Social Security alone.
Rather, do your best to save for your later years in a tax-advantaged retirement plan like an IRA or 401(k). Setting $300 a month aside over 25 years will leave you with about $228,000 in savings, assuming you invest your IRA or 401(k) at an average yearly 7% return (which is few percentage points below the stock market's average).
3. Social Security may be slashed in the future
Social Security is facing an income shortfall, as it anticipates owing more money in benefits than it collects in revenue in the coming years. The reason? A mass exodus of baby boomers from the workforce is expected, and not enough new workers will be coming in to replace them. Social Security has trust funds it can access to keep up with scheduled benefits in the absence of adequate revenue, but once those funds are depleted, major benefit cuts may be on the table.
In April, the Social Security Trustees estimated that the program's trust funds would run dry by 2035. But that unwanted milestone could come sooner, thanks to the loss of payroll tax revenue that the COVID-19 pandemic has already resulted in. As such, you may need to gear up for a lower benefit than you'd otherwise be entitled to.
Know the ins and outs of Social Security
The more you know about Social Security, the better you'll be able to prepare for retirement. Be sure to spend some time reading up on how the program works to avoid unpleasant surprises that could derail your planning and cause you an undue amount of financial stress.