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Social Security is the most common source of retirement income, according to the Report on Economic Well-Being of U.S. Households as of May 2021. Being that it’s such a substantial source of income, how do you know you are making the proper elections with your own Social Security? Should you delay benefits? How will this income be taxed?
Deciding when to take your Social Security benefit is both an emotional and financial decision. Many people continue to work after retirement or are working past the key Social Security ages of either 62 or age 66. You can begin to take benefits at age 62, delay until between age 66 and age 67 depending on when you were born or wait until age 70 to maximize your benefit.
When To Begin Taking Social Security Benefits
The general calculation is that retirees who start to collect Social Security Income at age 62 rather than at their full retirement age (66 or 67) can expect to receive about 30% less in benefits than if they waited for the full retirement age because they made the early election. Additionally, if a worker continues to earn income after age 62, this can potentially increase the benefits because of how the Social Security income calculation works. Monthly benefits are determined by your average indexed earnings during the 35 years in which you were the highest paid. Does it make sense to work to age 67 and then collect benefits? The answer is, “it depends.” If a worker has hit their 35-year threshold at age 62 with plans to start Social Security benefits at age 67, AND their income is not likely to grow from ages 62-67, then there would most likely be a small increase in monthly benefits. However, if a worker can increase their income from ages 62-67, thus bringing up their 35-year average, then it would make sense to work if the goal were to maximize the potential Social Security benefit.
Tax Implications of Social Security Benefits
It is also important to understand how Social Security benefits are taxed. Social Security income is subject to Federal income tax and is subject to state tax in 13 states. (To check to see if your state imposes income tax, check with your tax professional or your state’s department of taxation.)
The amount of benefit that is included for tax depends on overall income; however, regardless of income, the maximum portion of the benefit that will be subject to tax is 85%. For example, if a retiree is married and files a joint return earning over $44,000 of income, they may have 85% of their benefit taxed, and 15% of their benefit tax-free. If the total income is between $32,000 and $44,000 of earnings, up to 50% of the benefit is taxable.
When budgeting for retirement, making a distinction between before-tax and after-tax dollars can have a significant impact on overall wealth. Remember, if relying on Social Security as a source of income, you get to spend the net amount after taxes, not the gross amount before taxes.
Where to Learn More About Social Security: Not all Sources are Created Equal
Advancements in technology can also help you to calculate and maximize social security benefits. A simple online search can net a trove of benefits calculators and resources to help you maximize benefits. Always remember to consider the source of this information, however: third-party websites and articles can be helpful, but oftentimes, the information may be general and not pertain to your specific needs. Calculators may be simplistic and not enough to determine the best outcome. On the flip side, some of the more comprehensive software can be costly or confusing. Many professional accountants or financial planners have access to these resources and can help determine the right election strategy.
Looking Forward: What Does the Future of Social Security Look Like?
The Social Security program has come a long way in its 87-year history. Since Earnest Ackerman became the first person to receive a benefit of the lump sum of 17 cents in 1937, many Americans count on this income source, as well as its newer features such as the cost-of-living adjustments (COLA) to increase this benefit to keep pace with rising prices. As we head into the future, there is uncertainty as to the sustainability of the program.
Studies have shown that the trust fund will be exhausted by the year 2034, only 12 years away! Since no major legislation has been passed since the early 1980s (when Congress made a portion of the benefits taxable and increased the retirement ages), Congress will be forced to act, or risk a majority of benefits being cut by nearly 25%. One of the reasons for this potential shortfall is that the program was meant to have a balance of workers and employers contributing into the program via payroll tax with retirees simultaneously withdrawing from the fund. Since the population boom of 1946-1964, a.k.a. the baby boomers, that ratio of retirees to workers will be off balance. The population is also declining because people are having fewer children. This ultimately leaves Congress with two options: cut benefits by reducing the dollar amounts/increasing the retirement ages, or increase payroll taxes. Since legislation for Social Security needs more than just a majority vote of 51 senators, it will need bipartisan support to be passed into law.
Understanding how Social Security works and fits into your specific financial plan is very important. Additional care should be given as to how these benefits will impact your retirement, as well as the legislation and potential changes surrounding Social Security.
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