Everybody could use a little extra income come retirement time. In the United States of America most retirees can count on social security to provide an extra bump in their income. Retirees who receive this pay are entitled to the money because they paid social security taxes throughout their career. In a recent survey it was found that current retirees rely on social security for roughly 40% of their monthly income. The other 60% is derived from pensions, savings (including defined contribution plans), part-time work, and other sources.
As mentioned in a previous post, if changes aren’t implemented to the social security program soon then benefits could be drastically lowered by the year 2035. Just how much of a reduction could people see? One study puts the amount at nearly 25% less, meaning that you would only get .75 for every dollar that you’re currently entitled to. Since the average monthly benefit is currently around $1,360 this would decrease the monthly income by almost $350. So what changes could be made to the system to keep the payouts where they are currently? There are a number of options, and odds are that to actually fix the system the government would have to implement several of them, hopefully none of them to a drastic extent, however. A few of the options that could change the program are listed below:
Increase the individual tax rate paid into the program – 6.20% for SS and 1.45% for Medicare in 2017
Increase the full retirement age at for benefit payouts – Currently age 66 or 67 depending on birth year
Remove (or adjust) the maximum annual earnings that are taxed – $127,200 in 2017
Adjust the formula for benefit payouts
Means testing the recipients
Although it’s fun to speculate on what changes could be made to the program, that’s not the intent of this blog post. Since there isn’t too much control that you have on the actual mechanics of the program we will let the politicians worry about solving the social security conundrum. This post is about the things that you do have control over and what you need to know. The good news is that even if the benefits are reduced, the program will still exist and you’ll still receive some sort of payout. Since we don’t know what changes will be made in the future, however, we will just look at the numbers today to better understand what we need to accomplish. As long as you’re doing your part to save for your own future, and only consider the social security benefits as a bonus, you’ll be well off in retirement.
How Are Benefits Determined?
Social Security benefits are determined by using a complex formula. This formula is based on your average annual earnings for the highest 35 years of your career. The wages in each year are also inflation adjusted. We won’t get into the specific formula but just know that the more you’ve made throughout your career the higher your payouts will be upon retirement. Another factor that will increase or decrease your benefits is the age at which you start receiving benefits. In general the longer you hold out on receiving benefits, the higher your benefits will be. The earliest that a person can receive benefits is age 62 while the oldest that a person may be before taking benefits is age 70. There are many retirement calculators available online but for an accurate social security estimate use the one directly on the SSA website. This will use your actual earnings history to estimate your future payments.
Take a look below at the different social security checkpoints that I have outlined. As you move down the list each checkpoint will be a little bit more difficult to obtain, but if obtained will result in a higher payout upon retirement. At the bottom of each checkpoint I list the amount a person could expect to receive in monthly social security benefits today (assuming benefits are taken at full retirement age, currently age 67).
Verify you’re paying into social security
The first step to being entitled to future benefits is to ensure that you’re paying into the social security program. This means that you’re paying social security taxes on your earnings. This isn’t something that you can just opt out of, however, so odds are you are paying into it. Even people who are self-employed are required to pay social security taxes. Certain groups, however, are exempt from paying social security taxes. People who may not be paying into social security include certain government employees who receive defined benefit plans, specific religious groups, and also certain foreign students and professors. If you are unsure of whether you pay into social security just take a glance at your most recent paystub. This should confirm that you’re paying into social security. Your paycheck will most likely label a line of your taxes as social security taxes. If you do not see this look for an OASDI (Old Age Survivors and Disability Insurance) tax.
Estimated amount per month if this checkpoint is the last one obtained: $0
Ensure that you have hit (or will hit) 40 social security credits
Social Security credits are used to verify that you’ve been paying social security taxes for a certain number of years. This essentially blocks people from working just a couple of years and then trying to receive social security benefits. The total number of credits needed to receive benefits is determined based on age but to be safe you should plan on accumulating 40 credits by retirement (this is currently the most needed). A total of four credits may be earned per year. Currently, a credit is earned based on your earnings. If you make more than $1,260 a quarter, and are paying into social security, you will receive a credit. If you’re working full time, or even part time, you most likely won’t have trouble hitting this threshold as it amounts to making about $420 a month.
Estimated amount per month if this checkpoint is the last one obtained: $0 - $796
Earn an average of $10,620 per year for your highest 35 years of earnings
This breaks down to $885 of monthly income during your 35 highest years of earnings. Within the social security formula there are two “bend” points at which how much you will receive in retirement will fluctuate. This $885 monthly figure is the amount to hit the first bend point. As many of you know, social security is designed to assist those who need it most financially. Because of this the social security formula is weighted to give lower income earners more of a percentage of the benefits than higher income workers would be entitled to relative to taxed paid. In fact, you’ll receive about 90% of your earnings for the first $885 per month that you make. Because of this it’s crucial that you at least try to hit this checkpoint. As you can see below, if you can at least hit this checkpoint, and go no further, you will at least receive a minimum of $796 per month in benefits.
Estimated amount per month if this checkpoint is the last one obtained: $796 - $2,220
Earn an average of $64,032 per year for your highest 35 years of earnings
Now things start to get interesting. Hitting an average of $64k in earnings for 35 years is a difficult task indeed, especially considering the fact that younger earners will earn considerably less. The good news here is that the wages are inflation adjusted. This means that the dollars you earned years ago will count much more towards the total than dollars earned today. After obtaining the checkpoint prior to this, any increase in average monthly income will get paid out at 32%. Although not nearly as good as the 90% payout in the prior checkpoint this is still a substantial amount.
Estimated amount per month if this checkpoint is the last one obtained: $2,220 - $2,686
Max out your social security earnings for 35 years
This checkpoint is the final one. It’s also extremely difficult to obtain. I don’t know the true numbers but I’d assume it’s around 1 in only 10,000 people. This checkpoint is to max out your yearly earnings for 35 years in regards to the social security cap. In 2017 the cap is $127,200. Any earnings above this amount do not get taxed for social security purposes. Many people will hit the social security cap in a year, but the difficult task would be to do it in 35 years of a person’s career. One reason this checkpoint is so difficult is because most people who are starting out in the workforce will be nowhere near hitting the cap. In most industries it takes years of experience, as well as steady raises, to hit the annual cap. Another reason the checkpoint is so difficult is because even if a person does happen to consistently hit the annual cap, odds are they will stop working before they hit the 35 year mark. They most likely will have accumulated enough earnings to retire early and not have to rely so much on social security.
Estimated amount per month if this checkpoint is the last one obtained: $2,687
As you can see trying to predict your social security benefits is rather confusing. It’s even more confusing if we try to factor in different inflation adjustments or any changes that could come from lawmakers. The best we can do is to keep paying into the system and trust that when it’s our time to retire that the system will still remain largely intact.