Image: SSA.
This article was updated on Dec. 28, 2015.
Tens of millions of Americans receive Social Security, but very few of them truly understand the ins and outs of the program. Indeed, there are many aspects of Social Security that almost no one really knows; yet they can have a huge impact on your financial prospects in retirement. Let's take a closer look at three key facts that you really ought to know about the Social Security program.
1. Social Security benefits are progressive and favor low-income workers
Many people mistakenly believe that the amount of taxes they pay directly influences how much they'll receive in Social Security benefits. They assume that if they made twice as much money during their careers and paid twice as much in Social Security payroll taxes, they'll get twice the monthly benefit of the lower-earning person.
Social Security doesn't work that way. Its progressive benefit formula pays a high percentage of your average monthly earnings up to a certain point; but then, as your income grows, lower percentages apply to bring down your overall benefit as a percentage of your career income.
Specifically, as you can see below, the Social Security Administration calculates your primary insurance amount -- the figure that determines your monthly checks -- by looking at your average monthly earnings. In 2016, 90% of your first $856 in earnings goes toward your Social Security. For the next $4,301 in earnings, however, only 32% goes toward your benefit, and for any earnings above $5,157, a 15% rate applies.
Data: SSA.
The result is that Social Security returns a greater percentage of income to low-income workers than to high-income workers. That's consistent with the program's purpose as a safety net, although some believe it's unfair that those who pay more in taxes don't get correspondingly bigger benefits.
2. Social Security doesn't cover everyone
With Social Security providing benefits for so many people, it's natural to assume that every American must be covered. But there are eligibility rules for Social Security, and many people don't meet them, and therefore won't get retirement benefits.
In particular, in order to get Social Security benefits based on your own work history, you need to have at least 40 credits with the SSA. For 2016, every $1,260 you earn in wages or other earnings gives you a credit, and you can earn a maximum of four credits per year. What that means in practical terms is that most people have to work 10 years to get retirement benefits based on their own work history.
Of course, married people can claim spousal benefits based on their spouse's work history, and those whose spouses have died can generally get survivors benefits. Again, though, the spouse whose work history is being used to claim benefits has to meet those eligibility rules.
3. The Social Security Trust Fund doesn't need to worry about rising interest rates
The Social Security Trust Fund is only allowed to invest in U.S. Treasury bonds, and many people have worried that if interest rates start to rise, bond prices could fall, hurting the Trust Fund financially. But the Trust Fund invests in a special type of bond that's only available to it, and one of its features is that its price isn't affected by rate changes. The Trust Fund always has the right to redeem its bonds at full value.
That doesn't mean that the Trust Fund isn't affected by interest rates. Low rates have actually hurt the Social Security program, because they've reduced the income available to help pay benefits. Offsetting that pressure, though, is the fact that low inflation has kept cost-of-living increases to a minimum, with no change at all to Social Security benefits in 2016. On the whole, Social Security faces some big financial problems, but interest rates are far from the biggest.
Social Security has some complexities that few people understand. By knowing about these three facts, though, you'll put yourself ahead of the game and have a better chance of getting the full benefits you deserve in retirement.
