Social Security, Let's Start with the Basics

October 13, 2020

Social Security, Let's Start with the Basics

A brief history...

In 1935, Social Security was started as a resource to help the elderly and disadvantaged. Have you ever seen something called "FICA" taken out of your paycheck?  FICA stands for Federal Insurance Contributions Act and those payroll taxes, in addition to the Self Employed Contribution Act (SECA), are the funding mechanism for Social Security. 

In retirement, Social Security serves a an ongoing income stream to help individuals meet monthly obligations, in addition to their other sources of income.  Much like income from many jobs, once a year, Social Security recipients typically receive a cost-of-living adjustment, though the amount is typically minimal.  Please reference the Social Security website for historical adjustments. 

https://www.ssa.gov/oact/cola/colaseries.html

Another important role of Social Security is providing benefits/cash flow to those who have lost a spouse or a parent, this topic will be covered in a future post.

The Breakdown...

Employee:

  • 6.20% of the first $137,700 in wages are taxed as a contribution to Social Security
  • 1.45% is taxed as a contribution to Medicare, with no limit on earnings

Employer:

  • 6.20% of the first $137,700 in wages are taxed as a contribution to Social Security
  • 1.45% is taxed as a contribution to Medicare, with no limit on earnings

Who is eligible?

Over your lifetime, you earn credits during your working years, that in turn, make you eligible for Social Security.  Each year, you can earn up to four credits, and you need 40 credits to be eligible, so that equates to approximately 10 working years.  Fun fact, credits are earned based on dollars of earnings.  For example, in 2020, for every $1,410 of earnings, you receive one credit...until you have earned a maximum of 4 credits for the year, regardless of how many dollars you actually earn.  

So, let me get this straight...If I work 10 years and earn 4 credits every year, does that qualify me for the same Social Security payment as my neighbor?  No, in fact, many other components factor into your monthly calculated Social Security payment.  

How long do I have to work to MAXIMIZE my Social Security payment?

The length of time that you worked over your lifetime also factors into calculating the payment you qualify for.  Did you know that Social Security typically uses your highest-earning 35 working years as the basis for the calculation?  So, if you work less than 35 years, you may receive a lower monthly payment, because $0/year is utilized for the missing years.  

When do I need to work those 35 years to qualify for a higher payment?  That's up to you.  The working years need not be consecutive, so taking a few years off to raise your children will not penalize you.  Just keep in mind, those are your highest-earning years, so working another year or two at your highest earning amount may not be a bad idea if you are trying to replace a few lower earning years from your youth.  

When can I start taking Social Security benefits?

You can begin taking Social Security benefits as early as age 62, but depending on your situation, that may not be the most advantageous.  On your Social Security statement, you'll see numbers referencing an amount at age 62, an amount at your Full Retirement Age (FRA) and an amount at age 70; with amounts increasing with your age.  Because this topic is too broad for our "basics" discussion, this will also be tackled in a different post.  

Will Social Security be there for ME at retirement?

Great question.  Remember the formula above?  Paychecks of current workers are being assessed payroll taxes to fund the current distributions of Social Security.  Using a little back-of-the-napkin math, we could say that if payroll taxes are more than Social Security is distributing...that's a surplus; if however, payroll taxes are less than Social Security payments, we have a deficit problem.

Ways that the "system" could be corrected in the event of deficits: raise payroll taxes, increase the penalty for taking Social Security early at age 62, reduce benefits to current or future recipients, or some combination thereof.  Much like in a financial plan, we can save more, spend less or work longer. 

My advice, generally speaking, is save more as part of your financial plan.  Run a financial plan without Social Security payments or with reduced amounts and make sure that your plan still works.  Make sure that your cash flow in retirement is still sufficient.  Social Security Statements currently display the following disclaimer:

"* Your estimated benefits are based on current law. Congress has made changes to the law in the
past and can do so at any time. The law governing benefit amounts may change because, by 2035,
the payroll taxes collected will be enough to pay only about 79 percent of scheduled benefits. "

https://www.ssa.gov/myaccount/assets/materials/SSA-7005-SM-SI%20Wanda%20Worker%20Mid-career.pdf 

What can I do now to learn more about Social Security and how it will affect my retirement plan?

Build a financial plan. Evaluate the sufficiency of your current retirement savings and sources of cash flow.  Be more dependent on you and your own savings plan than reliant on Social Security, due to the uncertainty of future benefit amounts.  Have a plan.  Arriving at retirement and assuming that the numbers will all work out is risky, plan early and frequently whether you are just out of school or well-established in your career.  Give me a call today if you would like to discuss your current retirement strategy and to better understand how Social Security impacts you. 

Stephanie L. Suhrbier

ssuhrbier@wradvisors.com

605-306-3248

 

This is meant for educational purposes only.  It should not be considered investment advice, nor does it constitute a recommendation to take a particular course of action. Please consult with a financial professional regarding your personal situation prior to making any financial related decisions.  (10/20)