An Introduction to Social Security
Key Takeaways
The average monthly benefit received by retired workers = $1,825
Social Security is primarily funded through payroll taxes received from employers and their employees at a rate of 6.2% each.
As of 2023, the Social Security portion of FICA will only tax up to $160,200 of earnings.
You can claim Social Security as early as 62 (60 if you are a qualified widow or widower) and as late as 70.
Your Full Retirement Age (FRA) is the age at which you can receive 100% of your Social Security retirement benefits. Your FRA will vary depending on the year you were born and is somewhere between 66 and 67.
Welcome to the first installment of our Social Security series: An Introduction to Social Security. This article, and the others within our Social Security series, will focus on the particulars related to retirement and survivorship benefits. We will not be overviewing social security disability insurance (SSDI) because that subject is deep enough to be a separate series. More specifically, our Social Security articles will cover the following:
Earnings Reduction Issues to Consider When Taking Social Security Early
Benefits of Delaying Social Security
What is the Best Age to File for Social Security Benefits?
How Do Marriage and Divorce Affect My Social Security Benefits?
The Ins and Outs of Social Security Survivor Benefits
Understanding How Social Security is Taxed
What You Need to Know About the Windfall Elimination Provision and Government Pension Offset
How to Optimize Social Security Within My Retirement Income Plan
Will Social Security Ever Go Away?
What Is Social Security?
Established in 1935 by Franklin D. Roosevelt, Social Security is a government program that provides financial support to eligible individuals and their families. FDR introduced this program during an era when the average life expectancy for a 65-year-old was 14 years. Today life expectancy for a 65-year-old is over 20 years. Therefore, the program has needed to evolve since its inception, but the overarching framework remains.
Most Americans nearing retirement are probably already familiar with Social Security because they've seen their FICA taxes deducted from their paycheck for nearly four decades. Finally, after all those years, you get to collect something back from our government! In most instances, this social welfare system acts as a partial income replacement in the form of pension-like payments for the rest of a retiree's life.
How Does Social Security Impact Retirees?
The reality is that Social Security plays a vital role in a retiree's overall retirement income plan. In fact, for some retirees, Social Security can be their primary source of income. According to the most recent Fact Sheet published by SSA.gov, for 27% of the elderly population, Social Security is 90% of their retirement income. Moreover, Social Security benefits replace about 37% of past earnings for the average American.
"Alright, enough with the history lesson; what about the income? How much does the typical person get? What's the highest income amount someone can get?" To answer those questions, here are the latest stats as of December 2022:
The average monthly benefit received by retired workers = $1,825
The maximum monthly benefit at full retirement age (FRA) = $3,627
How is Social Security Funded?
Social Security is primarily funded through payroll taxes received from employers and their employees at a rate of 6.2% each. When including Medicare with Social Security, the combined rate is 7.65% each – commonly called your FICA taxes. Something else to be mindful of, if you own a small business or are self-employed, is that you pay the entire 15.3% FICA tax (7.65% x 2).
As of 2023, the Social Security portion of FICA will only tax up to $160,200 of earnings; however, there is no earnings limit to the 1.45% Medicare tax. Also, individuals with earned income of more than $200,000 ($250,000 for married couples filing jointly) pay an additional 0.9% in Medicare taxes. Thanks for taking more of my hard-earned money, Uncle Sam!
When and How am I Eligible for My Social Security Benefit
To qualify for Social Security benefits, you must earn Social Security credits. You can earn up to 4 credits per year; individuals generally need 40 credits to be eligible for retirement benefits. As of 2023, the earnings required to obtain one Social Security credit is $1,640. Once you qualify, Social Security will take the average of the highest 35 years of earnings to compute your benefit. For years with $0 earnings, those may be counted within the average 35-year calculation. From there, your monthly retirement benefit is based on the age you elect to receive your benefits.
You can claim Social Security as early as 62 (60 if you are a qualified widow or widower) and as late as 70. When claiming your benefits, your Full Retirement Age (FRA) is the age at which you can receive 100% of your Social Security retirement benefits. Your FRA will vary depending on the year you were born and is somewhere between 66 and 67 – noted in the table below:
How do I Calculate My Social Security Benefit?
Effectively, if you wait to take your benefit after FRA, Social Security will pay you a higher retirement benefit than your FRA income amount (i.e., more than 100%). Conversely, if you elect your benefit before FRA, your benefit is reduced relative to what you would have received at FRA (i.e., less than 100%). Figuring out the optimal age to begin taking your Social Security benefit will be discussed as the primary topic in a later article within our Social Security series, as several important considerations come into play. At a high level, each person's unique situation will largely drive the optimal outcome.
It's important to note that Social Security provides an annual Cost of Living Adjustment (COLA) to account for inflation. In other words, your monthly benefits can maintain some of their purchasing power throughout the duration of your retirement.
In summary, the combination of your age, historical earnings, and COLAs drives how your monthly retirement benefit from Social Security is calculated. The actual calculation involves other technical terms like the Primary Insurance Amount (PIA), Average Indexed Monthly Earnings (AIME), and bend points, yet that is where things can be confusing for the average retiree.
If you have the desire to become an actuary and really want to nerd out with how Social Security is calculated, read the SSA.gov article Social Security Benefit Amounts. The bottom line is that your Social Security retirement benefit will pay you the higher of your own benefit or half of your spouse's benefit, and divorced people that did not remarry are eligible to receive half of their ex-spouse's benefit as long as they were married for ten or more years. Widows and widowers are entitled to the higher of their benefit or their deceased spouse's benefit.
Remember This…
For retirees seeking their desired outcome, planning for your retirement and understanding how Social Security fits into your overall financial plan is critical. That being said, you can create a "my Social Security" account on the official Social Security Administration website to access your personalized benefit estimates and other helpful information related to your benefits.
Suppose you are one of those people thinking about taking your benefit because you fear Social Security may run out of money and won't be around anymore. In that case, stay tuned for the next installment in our Social Security Series: Earnings Reduction Issues to Consider When Taking Social Security Early.
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