Have you ever plugged something into a wall outlet like a vacuum or toaster and stopped to think about the complexity of our electricity grid? No? Is it just me?
I think we are so accustomed to plugging something into the wall and having it power on that it’s easy to ignore all of the complexities that make it work. From generating the electricity to carrying it in power lines, to downsizing the power for a home, then for individual circuits. The point is: some things that appear simple initially are actually way more complex when we really stop to think about it.
I found this to be the case for Social Security. I knew taxes are taken out of my paycheck to pay into Social Security. I knew that one day, I would receive payments back from the program. However, outside of that, I didn’t know much about the more detailed parts of the program. While I probably won’t have many reasons to fully understand the electrical grid, I am planning to retire someday, so it is important to have an understanding of how Social Security works. Let’s take a closer look!
How Is It Funded?
Social Security is funded by FICA taxes (Federal Insurance Credit Act). If you take a look at your paycheck, you will see this as a line item on the deductions. This tax covers both a Social Security portion of 6.2% and a Medicare portion of 1.45%, for a total of 7.65% paid by you. Your employer also pays 7.65% towards FICA taxes.
Social Security taxes do max out once you reach a certain income. In 2023, the Social Security tax does not apply to earnings above $160,200.
How Do I Qualify?
Qualification for Social Security is gained by earning ‘credits’ during your working years. As a caveat, I will only be talking about Social Security Retirement here. Disability and Survivors benefits have different rules.
To qualify for Social Security you must earn 40 credits in your working career. In 2023, each credit is earned by having an income of $1,640. You can earn a maximum of four credits each year. That means if you earn $6,560 ($1,640 x 4) in 2023 you will earn the maximum amount of credits you can in the year. Once you earn those 40 credits, you will qualify for social security retirement.
When Can I Take Social Security?
Your retirement age will vary depending on when you were born. For anyone born before 1960, the full retirement age ranges from age 66 to age 66 + 10 months. The Social Security website has a handy tool to help you determine your full retirement age.
For anyone born after 1960, the full retirement age would be age 67. This is when you will receive 100% of your expected benefit. With that being said, Social Security can be taken as early as age 62, and as late as age 70.
When Should I Take Social Security?
Your early Social Security Retirement age would be age 62. This is the earliest that you can take Social Security, albeit at a reduced rate. It is estimated that if you take Social Security at age 62, you will only receive about 70% of your full benefit.
You also have the ability to delay your Social Security. Every month waiting past your retirement age will increase the benefit until maxing out at age 70. At this age, there is no further benefit in waiting. If you were born after 1960, waiting until age 70 is estimated to increase your benefit to 124% of your full benefit. Let’s take a look at an example of how this would work:
| Age | Monthly Benefit |
|---|---|
| 62 (Early Retirement) | $1,400 |
| 63 | $1,500 |
| 64 | $1,600 |
| 65 | $1,734 |
| 66 | $1,866 |
| 67 (Full Retirement) | $2,000 |
| 68 | $2,160 |
| 69 | $2,320 |
| 70 (Delayed Retirement) | $2,480 |
Based on individuals born after 1960, using a $2,000 monthly benefit example. Calculated based on the How Your Social Security Benefit is Reduced table.
The question then becomes, when should I take my Social Security? The truth is that you may never know the perfect time to take your Social Security. If you live to 100, then it will probably have benefited you to wait until age 70. If you live to age 72, it will probably have benefited you to take Social Security early. Unfortunately, we don’t have a crystal ball to help us determine this. Therefore, the best course of action is to make an informed decision based on your life expectancy, your needs, and your ability or desire to continue working. Working with an advisor to consider your whole financial picture may also be a helpful step.
Is It Enough?
A big question is whether Social Security will be enough for us to retire on. It is estimated that for most people, Social Security will replace about 40% of their pre-retirement income. If you are a low earner, Social Security will generally make up a higher percentage, and if you are a high earner it will make up a smaller percentage. I don’t know about you, but if I took a 60% pay cut, it would be a struggle to continue my current lifestyle.
Therefore, it is generally recommended that you replace about 70% of your pre-retirement income. 40% of which comes from Social Security and 30% of which comes from other sources, namely savings and your retirement accounts.
A 401(k), 403(b), or IRA allows you to invest for retirement while receiving tax benefits specific to retirement accounts. This is one of the best ways to make up the 30% of earnings in retirement to help maintain our current lifestyle.
What about the Future of Social Security?
There has been some uncertainty around the future of Social Security. With people living longer than ever before, and smaller generations now paying into Social Security, keeping up the current benefit system may be a challenge. Stay tuned to the BPAS Blog and our LinkedIn page for more information about this trending topic!
Even more information is available on BPAS University.