Social Security is a critical program that provides a financial foundation for seniors across America, and its importance may grow in the coming decades.
As of May, based on a statistical snapshot provided by the Social Security Administration, 40.6 million retired workers are receiving a monthly Social Security benefit. By 2050, the U.S. Census Bureau is forecasting that the elderly population will have nearly doubled to 83.7 million from where it stood in 2012, and nearly all of these elderly persons should be receiving a Social Security benefit. If today’s reliance on Social Security is any indication — nearly 6 in 10 retired seniors count on Social Security to comprise the majority of household income — the strains on the program are only going to increase.
These “strains” are a concern because the Social Security and Medicare Board of Trustees’ recently-released report for 2016 calls for the Old-Age, Survivors and Disability Insurance Trust to burn through its $2.8 trillion in excess cash reserves by 2034. Assuming Congress enacts no new laws to boost payroll tax collection or reduce benefits, a benefit cut of up to 21% could be needed across the board to ensure the solvency of benefit payments through 2090.
Five ways you’re reducing your Social Security benefit
In other words, seniors need to ensure they’re doing everything they can to get top dollar from Social Security, especially with so many relying so heavily on the program. Unfortunately, there are plenty of pitfalls that are keeping seniors from realizing their full benefit-earning potential. If you’re not careful, these five pitfalls could reduce your Social Security benefit, too.
1. You’re taking benefits before reaching FRA
The most obvious way you could be shorting yourself of a healthy Social Security benefit is by claiming benefits before hitting your full retirement age, or FRA.
Social Security benefits can be claimed beginning at age 62; this is the age that a little more than 2 in 5 seniors will choose to file. However, for each year that seniors wait to claim Social Security benefits, their payment increases in value by roughly 8%. This holds true until age 70, which is where benefit increases max out. An eligible beneficiary is entitled to 100% of his or her benefit upon reaching their FRA, which is a dynamic number that varies based on birth year. For baby boomers this translates to between 66 years and 67 years of age. Thus, if you’re taking benefits at age 62, you’re lopping as much as 25% to 30% off of your FRA for each month for the rest of your life.
Waiting may not be the best approach for everyone, but the earlier you file, the lower your benefit payment will be.
Calculator: Social security retirement income estimator
2. You didn’t work 35 years
Another easy way to lower your Social Security benefit is simply by not working at least 35 years and instead retiring early.
The Social Security Administration calculates your monthly benefit payment by taking two figures into account. The first is your average earnings, which means that working in a better-paying job over your lifetime should help pump up your Social Security benefit once you retire.
The other is the length of your work history. Although you need just 40 lifetime work credits to qualify for Social Security benefits (which essentially amounts to 10 years of very part-time work), the SSA averages your income over a 35-year period in its monthly benefit calculations. For each year under 35 that you’ve worked, it averages in a goose egg ($0). The more goose eggs you have, the lower your average annual income will be, and the more your benefit will be reduced. The moral of the story is simple: try to work at least 35 years to maximize your monthly benefit.
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3. You kept working after filing for benefits
A lack of retirement savings could coerce a number of baby boomers, Gen Xers, and even millennials to work well past the traditional retirement age and into their late 60s or even 70s. But working after you file for benefits can have surprising consequences.
If you’re still working but begin receiving Social Security benefits before reaching FRA, you could be subject to having some or all of your Social Security benefits withheld. In 2016, the SSA limits your full-year earnings ability to $15,720 if you claim benefits before reaching your FRA. For every $2 earned in excess of $15,720, $1 is deducted from your benefits. If you’ll reach FRA in 2016, but aren’t quite there yet, your earnings ability limit rises to $41,880. Should you reach this mark, for every $3 earned in excess of $41,880, $1 is deducted from your benefits. The SSA does not withhold benefits if you file for benefits on or after your FRA.
The good news is that the benefits withheld could translate into a bigger monthly payment after you hit your FRA. Unfortunately, if you were counting on an income boost between age 62 and your FRA, and you plan to work, you may want to rethink that strategy.
4. You’re paying tax on your Social Security benefits
Reducing your take-home is also easy if you don’t have a withdrawal plan in place during or before retirement.
It’s an oft-overlooked fact, but Social Security benefits are taxable. Per the Internal Revenue Service, individuals can earn up to $25,000 annually, and joint filers up to $32,000 annually, without having any of their Social Security benefits subject to federal taxation. However, if individual filers earn between $25,000 and $34,000 annually, and joint filers earn between $32,000 and $44,000, half of their Social Security benefits become subject to taxation. Earn more than $32,000 as an individual tax filer or $44,000 as a joint filer, and 85% of Social Security benefits are taxable. Not to mention, 13 states tax Social Security benefits, including four that have no exemptions on income.
The point is that if you haven’t thought about how you plan to access your nest egg during retirement, the tax implications of your distributions, combined with your Social Security income, could come back to haunt you. This is where a Roth IRA, which allows your money to grow completely free of taxation and doesn’t count toward your annual income, could come in handy.
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5. You failed to coordinate your benefit claim with your spouse
A fifth way you could be unknowingly reducing your lifetime benefits is by failing to coordinate your claim with your spouse.
It’s a common misconception that a Social Security decision is all about you, when in reality your decision to file for benefits could have ripple effects for your spouse and/or children. On top of the 40.6 million retired workers receiving a monthly benefit are almost 6.1 million people (widows, widowers, children, and in rare cases, parents) receiving survivor benefits from eligible workers who’ve passed away. If you happen to be the high-income earner of your family and you choose to file for benefits early, you’re reducing the survivor benefit potential for your spouse and/or children if you pass away before your spouse does.
The solution here is pretty simple: Talk to your spouse and formulate a game plan that benefits you both.