Social Security can make or break retirement for many older adults. Nearly one-quarter of workers say their benefits will be their primary source of retirement income, according to a 2023 report from the Transamerica Center for Retirement Studies, so it pays to maximize your monthly checks.
That's often easier said than done, however, since Social Security can be confusing and complicated. While you don't need to know everything about the program, there are a few misconceptions that could be particularly costly.
Myth No. 1: Benefit reductions are only temporary
The age at which you begin taking benefits will have an enormous impact on the amount you receive each month. To receive the full amount you're entitled to, based on your work history, you'll need to wait until your full retirement age (FRA) to begin claiming.
Image source: The Motley Fool.
If you file earlier than your FRA (as early as age 62), your benefit amount will be reduced. A common misconception, though, is that these reductions are only temporary.
Around half of U.S. adults mistakenly believe that if they claim early, their payments will increase once they reach their FRA, according to a 2023 survey from the Nationwide Retirement Institute. In reality, when you file early, those smaller payments will be locked in for life. If you're taking benefits before your FRA and are expecting to collect larger checks later, you could be in for a costly surprise.
Myth No. 2: Social Security benefits are tax-free
Roughly half of U.S. adults also believe that benefits are tax-free in retirement, according to the Nationwide survey. While some retirees may be able to avoid taxes on their benefits, many people will face state taxes, federal taxes, or both.
State taxes will depend on where you live. Fortunately, there are 38 states that don't tax Social Security at all, and of the 12 that do, there are often exemptions based on age or income.
Many states have also recently phased out taxes on benefits (or are in the process of phasing them out), so it's best to check your state's tax laws to see whether your benefits will be subject to taxes.
Federal taxes, however, apply to everyone. They're based on a figure called your "provisional income," which is your adjusted gross income (such as retirement account withdrawals) plus half of your annual benefit amount.
| Percentage of Your Benefits Subject to Federal Taxes | Provisional Income for Individuals | Provisional Income for Married Couples Filing Taxes Jointly |
|---|---|---|
| 0% | Under $25,000 per year | Under $32,000 per year |
| Up to 50% | $25,000 to $34,000 per year | $32,000 to $44,000 per year |
| Up to 85% | More than $34,000 per year | More than $44,000 per year |
Source: Social Security Administration.
The only way to avoid federal taxes on Social Security is if your provisional income falls below $25,000 per year (or $32,000 per year for married couples). If you're earning more than that, you'll owe federal taxes on up to 85% of your benefit amount.
However, Roth IRA and Roth 401(k) withdrawals do not count toward your provisional income. If the majority of your savings are coming from those types of accounts, you could potentially lower your provisional income enough to get out of federal taxes.
Myth No. 3: Working after taking Social Security has no impact on your benefits
Many older adults choose to continue working after filing for Social Security. While that can be a smart choice in many situations, it could also reduce your benefits.
If you haven't yet reached your FRA, your income will be subject to the retirement earnings test -- which is an income limit that will determine how much, if any, of your benefits will be reduced.
| Earnings Test Income Limit | How Much Your Benefits Will Be Reduced | |
|---|---|---|
| If you won't reach your FRA in 2023 | $21,240 per year | $1 for every $2 you earn above the limit |
| If you will reach your FRA in 2023 | $56,520 per year | $1 for every $3 you earn above the limit |
Source: Social Security Administration.
Say, for instance, that you won't reach your FRA this year and are earning $30,000 per year from your job. In this case, your income is $8,760 above the $21,240 annual limit, so your benefits would be reduced by $4,380 per year -- or $365 per month.
Keep in mind, though, that these reductions are only temporary. Once you reach your FRA, the Social Security Administration will recalculate your benefit amount to account for the money that was withheld, and you'll start collecting larger payments.
Social Security can be confusing, but having at least a basic understanding of how your benefits are calculated will make it easier to avoid costly misconceptions. When you know what to expect heading into retirement, you can set yourself up for a more financially secure future.
