How to plan for Social Security in retirement is a concern for many. This article explores how social security works, what might happen with social security moving forward and when you might want to begin collecting your benefits.
Social Security was introduced in 1935, in the bowels of the Great Depression. This era was obviously hard on everybody back then, but it was especially hard on the elderly, as they had no safety net. Their working years had long passed, limiting any income prospects. The government introduced this system, one that would be funded by payroll taxes, to benefit the elderly.
How much will you need in retirement?
Whether you are near your retirement or further away, it is important to understand how social security might play a role in your retirement income. Do you think it will be a big part of your retirement, or a small part of it? [Do you know how much you need in retirement? Check out my article on the 4% rule of thumb!] I have outlined information in this article to give you an overview of how the system works today, things to consider and what things might look like moving forward.
How does social security work?
Workers pay 6.2% of gross (pre-tax) wages into the system every pay period, and the employer also pays 6.2% of the worker’s gross pay. If you’re self-employed, you pay the full 12.4% into the system on your own behalf. All of this funding each year, however, does not go into a personal account just for you, it goes toward paying the benefits for current retirees, those on disability and so forth. Any unused funds go to a special fund invested in treasuries (aka backed by the full faith of the U.S. government) to fund future beneficiaries of the program. When you reach your eligibility age, you start collecting. At that time, younger generations are funding the same system through payroll taxes to keep the system going.
What’s happened to social security over time and how secure is social security as you plan for retirement?
In the beginning, social security was focused on benefiting the elderly. Over the years, the program expanded, including somewhere in the 1950’s, opening up to cover disabled individuals. Over time, the government has made modifications to keep the system running. This includes continuing to raise the cap on the portion of your gross wages that are taxed, making adjustments to the age at which people can collect and many other tweaks here and there.
People have long speculated that social security is going to run out. It has been the talk of Washington for years. Remember Al Gore’s famous “let’s put social security in a lock box” that was parodied on Saturday Night Live over 20 years ago? The thing is, social security is highly important to a strong voting contingent, older Americans. And social security benefits people regardless of their political affiliation as well. Congresspeople are not likely to rock the apple cart by canceling the program.
As long as workers pay payroll taxes, the system will keep running in some shape or form moving forward. The social security system does face challenges for sure. Up until this year, the system took in more than it paid out. Now, we are starting to see more going out the door than is coming in. A large part of this is the huge wave of retirees hitting the system. People are also living much longer now than in the past, drawing funds for a longer period of time.
The latest estimate shows the system will bring in 78% of scheduled benefits moving forward and will be depleted by 2034 if something is not changed. Did you know that social security almost went broke in 1983 too? Congress had to act in order to make some adjustments to the program to keep it running. The same will be done to address the current situation. Have no fear.
What might happen with social security moving forward?
As you plan your social security for retirement, it is important to understand what might happen moving forward. In order to address the social security deficit, congress will likely consider a few actions, which might include:
1. Raising the social security income tax cap.
In the past 10 years alone, the cap has been raised by 34%. Today, Jeff Bezos, the richest person in the world, pays personal taxes at most on $142,800 of his gross income. Granted, he does pay a lot of payroll taxes for employees (remember that 6.2% paid by the employer?). There is obviously room to move on this perhaps to get more contribution out of higher-earning individuals. Regardless, year-after-year, the maximum gross income on which social security is taxed keeps growing for everyone. There could be some changes on how that is assessed on people in different income levels.
2. Removing the income tax cap altogether.
Another option is that congress could remove the social security tax cap altogether. And, instead of social security (FICA) being assessed on the first $142,800 of a person’s gross wages, it is assessed on ALL of the annual wages. This would, for instance, turn Jeff Bezos’s contribution from $8,854 annually today to much more.
3. Raising the full retirement age.
The full retirement age has already changed for those born 1960 and later. Prior to that, it was 65. Now, it is 67. It is conceivable that this will increase even further moving forward. And it makes sense since life expectancy is much longer than it has been in the past.
4. Increasing the payroll tax rate.
The social security payroll tax rate started at 1% back in the 1930s when the system was born. It has now been 6.2% of gross wages since 1990. It is likely that this will be due for some adjustment moving forward which would bring more funds into the social security system.
5. Taxing social security benefits.
Today, an individual can earn $25,000 of income while collecting social security and not have to pay income tax on their social security benefit. Income between $25-34k, 50% of the benefit is taxable. Beyond that, you will pay income tax on no more than 85% of the social security benefit. It could be possible that congress would begin taxing social security benefits for everybody and treat it as ordinary income moving forward.
6. Creating a means-based system.
Today, everybody, regardless of income, is eligible to collect social security. You put into the system, so you should be entitled to take out of the system when the time comes. There is chatter in Washington about creating more of a ‘means-based’ system. This would mean those making larger retirement incomes, for example, would receive less social security benefit. Because, the thought is, they don’t need as much. With a means-based system in place, some people at the very highest income level, might not receive a benefit at all.
Overall, as you can see, lots of speculation, but it is very clear that SOMETHING will happen, like it did back in the 1980s, to address the deficit and keep things running.
How does one qualify to collect social security in retirement and how do benefits get calculated?
Part of your plan to collect social security should involve determining if you qualify. In order to collect social security in retirement, you must accumulate 40 points with the Social Security Administration. A person earns a point for each $1,470 earned, with a maximum of 4 credits per year issued. So, basically, it takes the average person 10 years to earn all of their credits in order to draw from social security at their retirement. For instance, I’ve worked non-stop for the past 27 years. I have already earned my credits, so if I stop working today at 43, I will be eligible to receive social security benefits once I hit my earliest age to collect (currently, 62). Today, my full retirement age is 67, because I was born in 1960 or later.
Social Security benefits are based on your lifetime earnings. Social Security calculates your average monthly earnings during the 35 years in which you earned the most to come up with your benefit. For those born 1960 and later, your full retirement age is 67. If you decide to draw early, let’s say at 62, your benefits will be reduced by about 30%. The longer you wait to draw, the more you will earn each month when you start collecting.
Do you know how many credits you’ve earned? Do you know what your estimated benefit is at the early, full, or late collection stages? If you haven’t done so, create an account using My Account at the Social Security Administration website and check it out. The Social Security Administration keeps track of all of your earnings. Look through and make sure they have it recorded accurately.
Are you divorced and nearing retirement?
Did you know that if you were married for 10 years or longer previously, you can collect on your ex’s social security benefit? You can do this as long as you have not remarried and as long as the ex is entitled to social security. Note, this will NOT impact the amount of your ex’s social security benefits (although, I know some of you hope that it would, LOL). You should determine if your own benefit will be smaller or larger than collecting on their benefits.
When should I begin collecting social security?
When you collect your social security is very much a personal decision. You really need to ask yourself the following questions:
1. How long are you going to live?
This can be hard to tell. Look at your family history. When did your grandparents pass? Parents? Any known health issues in your family? What are YOU doing to change that dynamic? Do you live a healthier lifestyle than they do/did?
2. When do you need the money?
If you are banking on social security to be a big part of your retirement plan and you need the money sooner than later, you might be inclined to collect it as soon as you can. However, by securing other streams of income in your retirement…perhaps rental income, a part-time job, etc….you will rely on social security less and can potentially put it off until at least your full retirement age.
3. What’s your feeling about social security? Do you think it’s going to collapse completely?
If you happen to have a lot of angst over social security, and you think it is doomed to fail, you will be inclined to collect ASAP. I personally do not think the system is going away any time soon. It will just be adjusted as I described above to keep it living into the future.
4. Are you married?
When it isn’t just you, and you have to figure out the best strategy for both you and your spouse, there are lots of considerations. One big one being that one spouse can collect on another spouse’s social security benefit. You would obviously only do this if it makes financial sense to do so. By a higher income spouse holding off on collecting, it is raising the benefit for both spouses if both are collecting off of the same person.
Here’s my own personal plan
Since I am 4 years older than my wife, and women tend to outlive men, I plan to draw from my social security starting at 70. Why? First of all, my wife has been a stay-at-home mom for much of the time since our first daughter was born 10 years ago. Additionally, she has earned a lower wage over the years, doing her passion work in early childhood development. Second, we will not need the extra income by our calculations. Although I strongly believe social security will be there for us when we retire, I do NOT plan for social security as part of my retirement income.
By extending my withdrawal age to 70, I am maximizing my benefit since it is beyond the full retirement age (in essence, getting a permanent raise). Check out the impact of delaying here. I am also ensuring that my wife, one day potentially as a surviving spouse, will have the maximum benefit, collecting from my social security. Third, we are both in good health currently and live a healthy lifestyle. I have definitely had health issues in my family tree, but I do as much as I can, including running, eating a vegetarian diet and so forth to lengthen my lifespan. You never know though, do you?
In closing
What you do with your social security planning is a personal decision. I recommend that you sharpen your pencils and figure out what you’ll do if social security isn’t there by the time you retire. Will you have enough saved? Will you do a bit of work to make ends meet? As mentioned, I do believe we will have a system for the long haul. By planning for a world without it, however, you are ensuring that social security is an “icing on the cake” benefit that you can use for those extra vacations, fun money or your favorite charitable contributions. You are ensuring your financial independence and not relying on someone to provide for you.
Until next time.