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How Does Social Security Work?

By Maurie Backman - Updated May 24, 2017 at 11:05AM

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Here are the basics you need to know about how Social Security works, and how your FICA taxes fund the program.

This article was updated on May 10, 2017, and originally published on Nov. 22, 2015. 

Imagine living somewhere where you're 100% responsible for your own economic security, regardless of your age or health, with no one to bail you out if you find yourself in need of financial assistance. If you're a U.S. citizen, you don't have to worry about it. Through a little program called Social Security, the U.S. government has committed to providing for the economic security of its citizens.

Social Security is designed to provide retirement support for American workers who pay into the system. It is funded through FICA taxes (FICA stands for the Federal Insurance Contributions Act). The Social Security Administration levies a 12.4% tax on earnings (6.2% is paid by you, and 6.2% is paid by your employer) to fund Social Security benefits.

There's a good deal of confusion surrounding Social Security and how this vast program works, so let's go over the basics that every American should know.

Social Security card


How does Social Security work?

Social Security works by pooling mandatory contributions from workers into a large pot and then paying out benefits to those who are eligible for them. When you work, you pay into the system by having a portion of your earnings taxed and earmarked for Social Security. For 2017, the maximum taxable earnings limit is $127,200. Later on, when you become eligible for benefits, you get to collect them instead of paying for the benefits of others.

The Social Security Administration reports that $0.85 of every Social Security tax dollar goes to a trust fund that pays monthly benefits to retirees and their families, as well as the surviving spouses or children of eligible recipients who have died. The remaining $0.15 goes toward benefits for people with disabilities and their families.

Who can collect Social Security?

You can collect Social Security once you reach a certain age or become disabled (note: the SSA has a strict definition of "disability," and benefit applicants must go through a rigorous disability determination process). You may also be able to collect survivor benefits if you're the spouse or child of a recipient who has passed away.

In order to be eligible for Social Security benefits, you must earn enough "credits" during your working years. In 2017, you'll receive one credit for every $1,300 in earnings, up to a maximum of four credits per year. These credits will count toward your future eligibility even if you switch jobs or take a break from the workforce. The dollar amount needed to earn one credit is usually raised annually. If you were born in 1929 or later, you need 40 credits, or 10 years of work, to qualify for retirement benefits. You typically need fewer credits to obtain disability benefits.

If you're eligible for survivor benefits, then you'll receive a percentage of the original beneficiary's Social Security benefit. The amount typically falls into the 75% to 100% range.

When to claim your Social Security benefits

I can hear what some of you are thinking: "I can work 10 years and get benefits? Sign me up."

Not so fast.

Even if you've accumulated your 40 credits, you can't start claiming retirement benefits until you're aged 62 or older, and the longer you wait to start collecting those benefits, the bigger the payout will be. If you wait to claim Social Security until you reach your "full retirement age" -- which is determined by the SSA and is 67 if you were born in 1960 or later -- then you'll receive your "primary benefit amount," which is the full monthly benefit you're entitled to based on your earnings record.

The earlier you claim your Social Security benefits, the lower your monthly payment will be. For example, if your full retirement age is 67 and you opt to claim benefits at age 62, then you'll get just 70% of your primary insurance amount. If you begin collecting at 65, you'll get 86.7% of your monthly benefit. On the flip side, you can earn delayed-retirement credits for waiting past your full retirement age. For every extra year you wait to claim Social Security benefits, your eventual payout will increase by 8%. Your benefits max out at age 70, though, so there's no reason to delay benefits beyond that point.

If you're receiving Social Security disability benefits at the time you reach your full retirement age, then your disability benefits will automatically convert to retirement benefits, but the amount won't change.

How much will I get?

Your Social Security retirement benefits will depend on how much money you earned during your working years and your age at the time you start collecting benefits. Similarly, your Social Security disability benefits are based on your eligible lifetime average earnings.

The Social Security Administration sends out annual benefit statements, and yours should include an estimate of how much money you'll get once you reach your full retirement age. You can also use the Social Security online benefits calculator to estimate your monthly benefits. Keep in mind that the younger you are, the less accurate your estimate is likely to be, since your future earnings could affect your overall payout.

Will I be able to live off my Social Security benefits?

Your Social Security benefits are only designed to replace about 40% of your pre-retirement income. Most financial experts say you'll need 70% to 80% of your pre-retirement income to live comfortably in retirement, so you have to take steps to bridge that 30% gap (or an even larger gap if you'd like to live in style). That means you'll need to create dependable streams of retirement income. These can include savings in a 401(k) or IRA, annuities, and more.

Will Social Security even be around by the time I retire?

According to the Social Security Administration's latest report, the combined funds used to pay retirement and disability benefits are likely to be depleted by 2034.

But that doesn't mean all is lost.

The report also states that once those funds are gone, ongoing taxes should be sufficient to pay about 79% of benefits. Still, with the future of Social Security on relatively shaky ground, if you're nowhere close to retirement at this point, your best bet is to take matters into your own hands. Save aggressively, invest wisely, and think of your Social Security benefits as an added bonus. This way, you're less likely to be thrown for a financial loop if they don't end up coming through.

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