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The future of Social Security is unpredictable to say the least.
In fact, Pew Research Center reports that half of both the Millennial and Gen X workforce already dismiss Social Security as a viable source of their future retirement income.(1) Meanwhile some Baby Boomers—who are counting on the benefits—have seen the full retirement age climb to 67, forcing them to reconsider when and how to exit their careers.(2)
Whether you’re just starting your career or you’re getting ready to clock out for the last time, avoid future surprises by arming yourself with a clear understanding of how Social Security works.
I’ve answered seven common questions about Social Security:
- How does Social Security work?
- What is the history of Social Security?
- Will Social Security be around when I retire?
- When can I claim my benefits?
- Should I claim my benefits before full retirement age?
- How do I calculate my Social Security benefits amount?
- How does Social Security fit into my retirement plan?
1. How does Social Security work?
American workers pay Social Security taxes on their income. It’s an automatic deduction that’s based on what you earn. The more you earn, the more you owe Uncle Sam. However, there is a tax cap for high-income earners. In 2018, the cap stands at $128,400.(3) This means, if you’re not self-employed and you make $130,000, you’ll only be taxed for wages up to $128,400.
This year’s Social Security tax rate is 12.4%. If you work for someone else, you and your employer split the tax, paying 6.2% each. If you’re self-employed, you foot the entire 12.4%.(4)
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The taxes you pay aren’t stashed away in your own personal Social Security savings account. Instead, the Social Security Administration pools the money and uses it to cover current beneficiaries. Simply put: 81 cents of every Social Security tax dollar goes into a trust fund that pays benefits for current retirees, surviving spouses, and dependents of deceased workers. The remaining 19 cents heads to a trust fund that pays disability benefits for qualified Americans.(5)
2. What is the history of Social Security?
Social Security was created in 1935 to provide income for retired workers age 65 or older. Today, about 167 million workers pay Social Security taxes, and 66 million Americans received Social Security benefits in 2016.(6, 7) Who receives Social Security benefits?
- Retired workers.
- Disabled Americans.
- Survivors of deceased workers.
- Dependents of beneficiaries.
The Social Security Administration reports that 62% of retired Americans rely on Social Security benefits for at least half of their income.(8) For retirees 80 years or older, 72% rely on Social Security for more than half of their income. This means that as many seniors age, they rely more and more on Social Security benefits.
But Social Security was never intended to be the only source of income for Americans in retirement. It was designed to be a supplement.
Social Security has a negative rate of return as a savings program. You’d be better off stashing your money away in an old fruit jar. —Chris Hogan
3. Will Social Security be around when I retire?
Don’t count on it. Or don’t count on all of it. Here’s the deal: Social Security is fully funded until 2034. After that, there will be enough money to fund about 77% of scheduled benefits.(9) This means that, without reform, many Americans might not reap the full benefits of Social Security in retirement.
According to the Social Security Administration, 2.8 workers currently share the costs to cover one beneficiary. By 2035, that ratio will change to 2.2 workers per beneficiary.(10) Several factors contribute to that shift, with the primary one being the number of Baby Boomers who will retire in the next decade. It’s estimated that the number of Americans age 65 and older will increase from 49 million to 79 million by 2035, creating a strain on the system as it’s currently designed.(11)
As discouraging as this sounds, no one can predict just how Social Security will shake out over the next few decades. The Social Security Administration says it’s unlikely that benefits will disappear entirely. So, until 2035, it’s business as usual.
Keep in mind, whether Social Security is fully or partially funded when you retire, you’ll need other avenues of income to enjoy a comfortable retirement. For instance, the average post-retirement Social Security pay in 2017 is $1,369 per month.(12) That’s $38 less than the national poverty level for a two-person household.(13) That’s why it’s important to build your own retirement savings by investing a portion of your income in growth stock mutual funds through your company’s 401(k) plan or a Roth IRA. This is where your qualified investing professional comes in. They’ll help you create a plan and strategy that fits your individual retirement situation.
4. When can I claim my benefits?
According to the Social Security Administration, full retirement age is when a person is eligible for full or unreduced retirement benefits. The current full retirement age for people born in 1960 or later is 67.(14)
Work until age 67? Apparently, some Americans are okay with it. A recent Gallup Poll showed 31% of retirees plan to keep working past age 67.(15) While working longer is a wise goal, it might not be realistic for everyone. A report from the National Institute on Aging showed more people stop working due to poor health than because they have sufficient money to retire comfortably.
Unexpected life changes could derail your good intentions to work longer, so prepare in advance for that real possibility.
Start by calculating your full retirement age. That number will provide insight on when you can apply for Social Security benefits. It will also give you a date to work with as you’re planning your strategy for your 401(k) and Roth IRA.
5. Should I claim my benefits before full retirement age?
That’s a good question. And the answer is different for everyone. You can claim retirement benefits as early as age 62, or as late as age 70. If you claim your benefits before you’re the full retirement age, your monthly amount will be reduced to reflect the longer period you’ll receive them. However, delaying your claim will increase your benefits to compensate for the shorter period you’ll receive them.
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Look at it this way: Let’s say your full retirement age is 67 and you’d receive a monthly benefit of $1,000. If you begin claiming your Social Security at 62, your benefit would be $700. But if you wait to claim your benefit until age 70, it would increase to $1,240 a month.(16)
Even better: If you have sufficient savings and don’t need your Social Security benefits for living expenses, think about claiming your Social Security early and work with your SmartVestor Pro to invest every penny. If you invest $700 a month from age 62 to age 77, you could potentially have another $290,000 saved! That’s money your family could inherit—and it blows away the Social Security survivor benefit your spouse would receive! Again, this scenario is for folks who have solid retirement savings. If you need Social Security for living expenses when you retire, it’s best to work a few more years and claim the higher amount.
6. How do I calculate my Social Security benefits amount?
There are several variables that go into your individual benefit payout:
- Your lifetime earnings.
- Your age when you begin taking benefits.
- If you have enough credits to qualify in the first place.
Credits? Yes, credits. You’ll need 40 of them over your wage-earning lifetime to receive Social Security benefits. In 2017, workers receive one credit for every $1,300 they earn. Workers are eligible for four credits a year. There are some nuances for credit accumulation for certain jobs, so be sure to check the Social Security Administration website for up-to-date information.
As you can see, the math is somewhat mysterious, but you can check out your personal benefit estimate from the Social Security Administration.
7. How does Social Security fit into my retirement plan?
As it stands now, Social Security replaces only 40% of a person’s pre-retirement income.(17) Keep in mind, benefits could be reduced about 20% after 2034.
If your pre-retirement annual income is $55,000, right now Social Security will only replace around $22,000. You’ll need another $33,000 per year to maintain your pre-retirement income. As we’ve mentioned, that gap would ideally be covered by your retirement savings in your 401(k) and Roth IRA.
A simple calculation shows that $33,000 multiplied by 20 years of retirement comes to $660,000—the amount you’ll need in savings to bridge the gap between Social Security benefits and your pre-retirement income. That sounds like a lot, but saving that much is possible. If you invest the industry-recommended 15% of your annual income from age 40 to 67, you could have more than $1 million for retirement.
Realistically, retirees will most likely need 80% or more of their pre-retirement annual earnings to maintain their lifestyle throughout their golden years. Keep in mind, there are many complex financial variables like market volatility, inflation, and cost-of-living adjustments that will impact your overall personal retirement savings equation. That’s why it’s important to talk with your financial professional. They’ll walk you through those variables and help create a custom plan for your retirement.
If you don’t need Social Security for living expenses, take it and bank it. —Chris Hogan
Don’t Focus on Social Security. Focus on Retirement Security.
You should think of Social Security benefits as your retirement dessert, not your main course. If Social Security is around when you retire—great! Use the money to travel or fund a hobby. But don’t depend on Social Security as your main source of retirement income.
Begin now, and create a strategy that sets you up for a confident retirement without the government’s help. If you don’t know how to start, connect with a SmartVestor Pro in your area who can help you build confidence for your individual retirement needs.
About Chris Hogan
Chris Hogan is the #1 national best-selling author of Retire Inspired: It’s Not an Age; It’s a Financial Number and host of the Retire Inspired Podcast. A popular and dynamic speaker on the topics of personal finance, retirement and leadership, Hogan helps people across the country develop successful strategies to manage their money in both their personal lives and businesses. You can follow Hogan on Twitter and Instagram at @ChrisHogan360 and online at chrishogan360.com or facebook.com/chrishogan360.