Millions rely on Social Security for their livelihood in retirement, and given how little working Americans are setting aside in retirement savings, it's likely that dependence on Social Security will only keep growing in the years to come. And even though many of us rely on Social Security, few of us truly understand the program. Many people see Social Security as a complicated and perplexing system, making it almost impossible to figure out what benefits they can expect for themselves and their families.
There are several reasons why Social Security confuses so many people, but it's critical to understand Social Security and the benefits it offers. Let's start by getting a basic idea of what Social Security does for you. This will help you figure out what questions you need to ask in order to flesh out your Social Security planning.
1. How Social Security calculates your benefits isn't simple
Most of the time, when you set money aside in savings, it's pretty easy to understand the impact it will have on your financial future. The more you save, the more you'll have when you need it. And the math is simple -- for example, double what you set aside, and you'll have double your eventual nest egg.
Social Security doesn't work that way. If you double your earnings from $25,000 to $50,000, you'll also double the Social Security payroll taxes you have withdrawn from your check. But the way Social Security calculates benefits, your monthly payment in retirement won't double. Instead, it will go up by about 60% -- a nice jump, but not the doubling that most would expect to see.
The reason is that Social Security is a progressive system, with a benefits formula that increases benefits by a smaller amount as your earnings go up. The specifics of the formula make it tough to generalize, but the key point is that as your salary rises, it becomes more important to boost your own outside retirement savings in order to keep pace. Because Social Security will replace a smaller percentage of your earnings as your income goes up, holding your standard of living steady will require you to save more on your own.
2. Social Security wasn't really designed with two-earner families in mind
When Social Security started, single-earner families were the norm, and that explains the complicated system of family benefits that the program provides. When only one spouse works, Social Security is pretty simple: Assuming everyone claims benefits at full retirement age, the primary wage-earner gets a retirement benefit and the spouse gets a spousal benefit of half that amount, and when the primary wage-earner dies, the surviving spouse gets a survivor's benefit that's equal to what the primary wage-earner received.
But with two-earner families, things get trickier. The complication is that you can claim benefits either on your own work history or on your spouse's history, and that leads to complex strategies -- like file and suspend and filing as a spouse first -- that you have to consider in order to maximize your benefits.
The key is understanding that in certain circumstances, you have multiple options, and choosing the right one can get you more money. Once you have that basic point down, it's easier to get into the details of specific Social Security strategies without getting lost.
3. Pay-as-you-go funding from the government makes Social Security's survival uncertain
When private companies offer pension benefits, they have to set money aside long before their workers start collecting those benefits in order to ensure that they'll have the financial ability to make payments in retirement. Workers therefore have the corresponding assurance that their pensions will be there when they need them, and even when businesses fail, entities like the Pension Benefit Guaranty Corporation stand behind those pensions and provide replacement benefits to make most retirees whole.
Social Security, though, has no such requirement, instead using current tax revenue to pay benefits that workers essentially earned in the past. What that means is that future retirees have no property right in their benefits, and lawmakers could theoretically repeal Social Security in its entirety and abandon those Americans who had counted on it being there for them in the future.
As politically unlikely as it is for that to happen, the fact that it's possible makes it impossible to plan for every contingency. Nevertheless, by knowing the current status of Social Security and likely future changes to the system, you can plan for the most likely scenarios by boosting your own savings.
Social Security is confusing, but it doesn't have to be. By getting the basics down, you'll have a good starting point in your efforts to gain a complete understanding of what Social Security will do for you.