Millions of seniors today rely on Social Security to cover their living expenses. And once you're ready to make your retirement official, you may find that Social Security becomes a primary income source for you as well.
That's why it's so important to know the rules of the program ahead of retirement. There are certain elements of Social Security that tend to throw seniors for a loop, like these.
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1. Social Security only replaces a limited amount of income
Some people are of the impression that their monthly Social Security benefits will replace their former paychecks from work in full. In reality, if you're an average earner, you should expect the money you get from Social Security to replace about 40% of your pre-retirement wages.
To put it another way, if you attempt to retire on Social Security alone, you could end up taking about a 60% pay cut. If that sounds like too large a cut to you, then you'll need to make an effort to save on your own for retirement.
2. Social Security benefits may be slashed
Social Security's main source of revenue is the money it collects in payroll taxes. Each year, there's a wage cap put in place to determine how much income is taxed for Social Security purposes. Right now, earnings up to $160,200 are taxed, and next year, that cap is rising to $168,600.
The problem is that in the coming years, baby boomers are expected to exit the workforce in short order. And if those same people aren't working and earning an income, then they won't be paying into Social Security.
Now Social Security can keep up with scheduled benefits until its cash reserves, known as its trust funds, run dry. That's expected to happen in about a decade. From there, benefit cuts might happen if lawmakers don't manage to find a way to pump more money into the program.
That's yet another reason to try to build some retirement savings. If Social Security benefits are cut, they'll replace even less of your income.
3. Social Security benefits can be taxable
If Social Security is your only source of retirement income, then you may not have to worry about being taxed on your benefits. But if you have other income sources -- which, ideally, you should -- then a portion of your benefits may be taxed.
Whether taxes on Social Security benefits apply or not depends on provisional income, which is half of your annual Social Security benefit plus your non-Social Security income. If you're a single tax-filer, a provisional income of $25,000 to $34,000 could mean being taxed on up to 50% of your benefits, while a provisional income above $34,000 could mean being taxed on up to 85% of your benefits.
If you're married filing a joint tax return in retirement, these limits do rise a bit, but they're still pretty low. A provisional income of $32,000 to $44,000 could mean being taxed on up to 50% of your benefits. A provisional income above $44,000 puts you at risk of being taxed on up to 85% of your benefits.
One retirement savings strategy you can employ to lessen the likelihood of being taxed on your Social Security benefits is to house your nest egg in a Roth IRA. Roth IRA withdrawals don't count as taxable income and therefore are not included in your provisional income.
The more details you know about Social Security ahead of retirement, the less likely you may be to face unpleasant financial surprises. Do your best to read up on Social Security so you can approach retirement with more confidence.
