Chances are good we’ve all felt a bit like Rachel on “Friends” when she peruses her first paycheck in bewilderment and says, “Who’s FICA? And why’s he taking all my money?”
FICA stands for the Federal Insurance Contributions Act, or as most of us know it, Social Security. A portion of your paycheck is deducted as a payroll tax to fund Social Security benefits, including the retirement program it’s most commonly associated with.
But that amount doesn’t go into an account with your name on it to tap into later. Today’s workers are funding today’s retirees, with the expectation that when they become future retirees, they in turn will be funded by those future workers.
That’s just one of the components of Social Security that is frequently misunderstood. Here are eight questions I often get about Social Security retirement benefits that will help you understand the program and how it affects you and your financial future.
1. At what age can I start taking Social Security retirement benefits?
Although most are eligible to receive Social Security as early as age 62, there are a variety of factors that influence what may be the most optimal claiming strategy for your situation. The difference is in the size of the monthly benefit you will receive if you wait.
For many, age 65 is the magic number they’ve heard when retirement “officially” begins, and that was the minimum age to receive full retirement benefits when the program began. But as our life expectancy has increased — meaning which we will draw benefits for that much longer — so has the age at which we are expected to start taking Social Security. This chart shows how the full retirement age has inched up.
The longer you wait to retire, the bigger your benefit each month and for the duration of the time you receive it. If you’re able to delay collecting benefits until age 70, your monthly amount will increase even more. In fact, every month you wait to file from your full retirement age (currently 67 for those born in 1960 and later) until age 70, your benefit will increase a total of 8% per year. This chart shows how it works for someone whose current full retirement age is 66, demonstrating the bonus you’ll reap if you wait.
2. What is my monthly Social Security benefit based on?
The formula is a bit complicated but here are the main parts. First, the Social Security Administration takes your 35 highest earning years as their basis. Then they apply an inflation factor based on the first year they use since, as we know, $10,000 in 1970 wasn’t the same as $10,000 today. They will add up those 35 highest years (or fewer if you don’t have at least 35 years in the workforce) and divide it by the number of months to determine the average indexed monthly earnings (AIME).
Then, they will apply what’s called a “bend” point, designed to even out the system so those who had the least income get the most benefits. It’s a little complex, but it’s essentially a formula that changes with the national average wage index to ensure someone who doesn’t make a lot of income will be protected in the system. This chart shows the bend points used to determine this formula for the past few years, and this video breaks down how it works.
3. As a high-income earner, why am I paying so much in tax when I won’t get it all back?
This is a common grievance, given that the collected funds aren’t sitting in an account just for you, as discussed. Yet many people don’t realize that the amount they pay doesn’t rise commensurate with their entire income.
The government has created a Social Security wage cap, currently set at $147,000 for 2022. If your earnings exceed that amount, nothing over it will be taxed for Social Security. Therefore, someone who earns $147,000 and someone who earns $5 million pay the same into the Social Security coffers, according to current law.
So, even though you may not get every dollar back when you collect your benefit, there is a limit on the amount of your wages that are subject to taxes if you earn above the wage limit.
4. If I want to keep working, will it affect my Social Security benefit?
Many workers, particularly those in white collar industries, can keep working past their retirement age either part-time or on a consulting basis. My clients often view retirement as a time when they have more flexibility, yet want to do something that gives them purpose, fulfillment, connection and routine—which often is found in a job.
However, any sort of wages, whether a salary, contract or bonus, is earned income, which could reduce your Social Security benefit. If you are younger than full retirement age and earn more than $19,560—the annual limit for 2022—the Social Security Administration will deduct $1 from your benefit payment for every $2 you earn. In the calendar year before you reach full retirement age, that earnings ceiling bumps up to $51,960 and the amount you are docked goes down to $1 for every $3 you earn. Once you reach full retirement age, earnings of any amount no longer reduce your benefit payment.
The good news is that if your benefit is reduced due to excessive earnings, the money doesn’t just evaporate. Instead, the government will recalculate your future payments and increase them to reflect the benefits withheld because of earned income.
Any unearned income, such as that from interest and dividends from your stock portfolio or passive rental income, would not reduce your Social Security benefit—although it could factor into how it’s taxed. More on that next.
5. Do I have to pay taxes on Social Security?
Your benefit may be taxed as ordinary income at your regular tax rate, depending on how much other income you are receiving. The government will tabulate your income from all sources, which could be rental income, a pension, or investment income, to determine the portion of your Social Security benefit that will be taxed. The amount of your benefit that could be subject to taxes ranges from 0% to a high of 85%. This article from the Social Security Administrations shows the breakdown by income.
6. What if I started taking a Social Security payment and changed my mind?
If your financial situation changes, you may decide to halt benefits in order to help amp up your future monthly payment. If you are under full retirement age and elected benefits, you can pretend it never even happened for up to 12 months from when you first started receiving benefits by withdrawing your application and paying back the entire amount you already received.
Otherwise, if it has been more than 12 months since you started receiving benefits, you’ll need to wait until you reach full retirement age and then request a suspension. You’ll then receive credit for each month of the suspension, ultimately boosting your eventual monthly benefit.
7. Will the Social Security fund run out before I receive my benefits?
This is a valid concern many clients have, which becomes clear as you begin to consider demographics: While increasing numbers of retirees are often living longer, there are dwindling numbers of workers contributing to the system that pays out to them. What I tell my clients, based on what we know today, is that as long as people keep paying into the system and the government keeps collecting, Social Security benefits are expected to be fully funded until2034, when they will drop to 77% of scheduled benefits absent any changes.1
However, no one knows what those changes will be, and it’s important to plan conservatively for retirement. It’s a best practice to stress test portfolios against various events. By stress testing the effect of a Social Security benefit reduction in the context of a holistic financial plan, you can see how well your finances could withstand that shock – either alone or in conjunction with another event.
We consider this a vital exercise as clients approach retirement so they can see where they should make adjustments.
8. Should I depend on Social Security to fund my retirement?
This all depends on the quality of life you want. Above, we’ve covered issues such as the potential size of your benefit and the solvency of the Social Security fund. But people are often surprised to hear the maximum Social Security benefit they can earn. Even if they were high-wage earners throughout their career and waited until age 70 to collect, the top monthly benefit in 2022 is $4,194 (assuming you retire at age 70).2 Many find that doesn’t adequately fund the lifestyle they anticipate or the legacy they hope to leave.
That’s why it’s wise to start planning ahead for those golden years right now. Consulting with a financial advisor can help you clarify your financial goals and the steps it will take to achieve them. While Social Security will likely be one core piece of your retirement, for most people it shouldn’t be their only one.
Have More Questions About Social Security?
Your financial advisor can help answer any questions you might have about retirement and Social Security.
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This blog is for general information only and is not intended to provide specific legal, tax, or other professional advice. For a comprehensive review of your personal situation, always consult with a tax or legal advisor.
1 Social Security Administration, “Status of the Social Security and Medicare Programs: A Summary of the 2022 Annual Reports” https://www.ssa.gov/OACT/TRSUM/index.html
2 Social Security Administration, “Frequently Asked Questions: What is the maximum Social Security retirement benefit payable?” https://faq.ssa.gov/en-us/Topic/article/KA-01897#:~:text=For%20example%2C%20if%20you%20retire,maximum%20benefit%20would%20be%20%244%2C194
