Millions of seniors rely heavily on Social Security to make ends meet. If you're planning to do the same, you should know the ins and outs of how the program works. If you don't, you may get caught off guard by some of Social Security's rules and nuances, like these.
1. Taxes on benefits
You'd think Social Security would be something you're entitled to without having to worry about taxes. But unfortunately, those benefits are yet another senior income source the IRS could get its hands on. Whether that actually happens, however, depends on your provisional income.
Your provisional income is calculated by taking your non-Social Security income (including certain tax-free income you're privy to, like interest from municipal bonds) plus half of your annual benefit payments. If that total lands between $25,000 and $34,000 and you're a single tax filer, or between $32,000 and $44,000 and you're a married couple filing jointly, you could be taxed on up to 50% of your benefits. Worse yet, if your provisional income exceeds $34,000 as a single tax filer, or $44,000 as a joint filer, you may be subject to taxes on up to 85% of your benefits.
Generally speaking, if Social Security is your only retirement income source, you'll manage to avoid having your benefits taxed at the federal level. Keep in mind, though, that there are 13 states that tax Social Security to varying degrees, so if you decide to settle down in one of them, you'll risk losing a chunk of your benefits there.
2. Withheld benefits when you also collect a paycheck
Once you reach full retirement age, or FRA, which is when you're entitled to collect your monthly Social Security benefit in full, you can earn as much money as you'd like from a job without having that income impact your benefit payments. But if you work and collect benefits at the same time before reaching FRA, you may have some of your benefits withheld if you exceed the annual earnings test limit.
In 2021, you can earn up to $18,960 without losing any benefits. From there, you'll have $1 in Social Security withheld for every $2 you earn. If you'll be reaching FRA this year, the earnings test limit is higher -- $50,520. From there, you'll have $1 in Social Security withheld for every $3 you earn.
Withheld benefits aren't lost permanently -- they're added onto your monthly benefit once you reach FRA. However, claiming Social Security before FRA -- you can do so starting at age 62 -- will also shrink your monthly benefit for life, so keep that in mind if you're planning to continue working.
3. Horrendously low cost-of-living adjustments
Each year, Social Security benefits are subject to a cost-of-living adjustment, or COLA. COLAs are supposed to help senior maintain their buying power in the face of inflation, but in recent years, they've fallen short.
Between 2002 and 2011, COLAs averaged 2.43%. But between 2012 and 2021, they averaged just 1.65%. As such, many seniors on Social Security have struggled to keep up with their bills. Unfortunately, COLAs are tied to fluctuations in the cost of goods and services that don't necessarily relate to seniors, which is part of the reason why some lawmakers have been advocating for a better way of calculating them.
Surprises can be a good thing -- except when they aren't. If you're planning to rely heavily on Social Security during retirement, make sure you understand the many details associated with it. Otherwise, you could be in for a very rude awakening later in life.