An Introduction to Social Security Benefits | Information from our Advisors
For many Americans, Social Security is a vital component of their retirement plan. Because it may be paramount to your ability to retire, having a good grasp on how it works, how it’s taxed, and when to claim is very important. We will briefly discuss the history of Social Security and how it works today, how claiming at different ages impacts your benefits, and some tax implications. This will not be comprehensive, so we highly recommend you speaking with a professional about your specific situation, doing further research (ssa.gov is a good resource), or attending our upcoming webinar.
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A Brief History of Social Security
The idea of the United State’s Social Security program came from the needs created during the stock market crash of 1929 (the Great Crash) and subsequent period of Great Depression. This was the third economic collapse in fewer than 100 years. While attempts were made to protect U.S. citizens from such crises, they were not sufficient protection against the Great Depression.
Following the Great Crash, unemployment rose to above 25%, about 10,000 banks failed, and the GDP fell from $105 billion to $55 billion. The fallout continued well into the 1930s resulting in millions of people being unemployed and a large portion of the elderly population becoming dependent on others to support them. President Franklin D. Roosevelt’s plan for the Social Security program was signed into law on August 14, 1935, with the main goal of paying retired workers a continuing income. The Act also established several other welfare provisions that helped pull the country out of it’s tailspin.1
How Social Security Works Today
Today, Social Security is an important part of many Americans’ retirement strategies. In 2020 alone, 69.8 million Americans received benefits from programs administered by the Social Security Administration (SSA), with 5.8 million people receiving some form of Social Security for the first time.2
Social Security is funded in large part through payroll taxes. The current benefits are being funded by the current workforce’s contributions, leading to speculation that it may not be sustainable. As today’s workforce moves into retirement, the plan is to have younger generations continue to fund the program.
Your Social Security benefits are accrued based on the number of years you have worked and the amount in taxes you have paid into the program. Social Security counts the years you have paid taxes as “credits” for years that you have worked. Benefits are calculated based on the number of credits you have earned during your working years. It is useful to know your expected benefits as you strategize for retirement.3
When to Claim
Choosing when to claim Social Security is one of the most important decisions you will make for retirement. Generally speaking, the longer you wait to start receiving benefits, the greater your monthly pay will be. On the other hand, every year you wait, decreases the number of years you will receive benefits. We recommend that you speak with a financial professional to discuss your specific situation to decide a time for you to apply for Social Security that aligns with your financial goals and needs. When deciding what age to claim Social Security, there are a few options to consider:
Early Retirement Age:
The earliest age you can claim Social Security benefits is 62. If you claim Social Security before full retirement age, you will incur a penalty.4 With that in mind, why would you choose to take Social Security early? One possible reason is that your financial situation requires you to have the money; some money is better than none. Another factor may come down to how long you believe you will live. As mentioned above, the total amount of money you receive may be greater due to the increased number if years.
Full Retirement Age:
The exact age depends on when you were born (see table). “Full Retirement Age” is when you are eligible to receive the full amount of your Social Security benefits.3,4
Delayed Retirement Age:
You may delay your benefits beyond your full retirement age until you reach 70. If you wait until age 70, you will receive an additional percentage. After 70, the benefits stop increasing meaning there is no reason to delay beyond age 70.5
How Taxes are Impacted
Most forms of income are taxed by the government and Social Security is no exception. To properly plan for retirement, it is important to understand how taxes will impact your various income streams.
The Internal Revenue Service (IRS) uses the provisional income formula to determine the taxable amount. It is calculated by adding adjusted gross income, nontaxable interest, and 50% of Social Security Benefits. This number is then compared against specific thresholds to determine the appropriate amount.6
Some states also impose taxes on Social Security. Michigan is not one of those states, but if you reside in a state that taxes Social Security, it is important to understand the rules and exemptions in your state.
Tax Minimizing Strategies
- Diversifying Retirement Income
- Delaying Benefits
- Create Withdrawal Strategies
- https://www.ssa.gov/history/briefhistory3.html
- https://www.ssa.gov/policy/docs/chartbooks/fast_facts/2021/fast_facts21.html
- https://www.ssa.gov/retirement
- https://www.cnbc.com/select/when-should-you-collect-social-security/
- https://www.ssa.gov/benefits/retirement/planner/agereduction.html
- https://www.ssa.gov/benefits/retirement/planner/taxes.html