Today commemorates the signing of the Social Security Act by President Franklin D. Roosevelt on August 14, 1935. Since then, Social Security has become America’s largest retirement plan and the financial bedrock for millions of Americans including those who are retired, disabled, widowed, and orphaned. Without question, the solvency of Social Security is at hand with its trust fund expected to be exhausted over the next decade if Congress does not act immediately. However, the fact remains that Social Security plays a critical role in retirement planning as it impacts almost every working person and retiree. Social Security is a very complex system with many moving parts.
Here are a few Social Security concepts, such as understanding your benefits, spousal benefits, and taxation of benefits.
Understanding Your Benefits
Social Security retirement benefits are based on credits, with one credit being equal to one-quarter of work. You need to earn 40 credits or 40 quarters (10 years) of work to become eligible for retirement benefits. However, your retirement benefits are calculated using your highest 35 years of earnings. If for example, you worked 20 years, the remaining 15 will be counted as zeros, which means your benefits will be significantly lower than if you had 35 years. When planning for retirement it’s important to understand your benefits as the Social Security Administration stopped mailing statements over a decade ago, leaving millions of Americans in the dark. The easiest way to understand your benefits is by creating an online account at www.ssa.gov. Here you will find not only your benefit amounts at various ages such as early retirement 62, full retirement age (FRA), and age 70, but also your earnings history and other important details.
One of the most confusing aspects of social security is the spousal benefit. As a married person, you are entitled to the higher of your benefit or 50% of your spouse’s benefit at his/her full retirement age. For example, Mary, 62, is eligible for a benefit of $2,500 per month at her full retirement age of 66. Her husband Mark, 60, whose full retirement age is 66, is entitled to either his monthly retirement benefit of $1,000 or a spousal benefit of $1,250. The only way to collect a spousal benefit is when the other spouse collects on his/her benefit.
Deemed filing means whenever you apply for benefits you are deemed to file for all eligible benefits including spousal. This eliminates the ability to collect a spousal benefit while letting your own benefit increase. Two very popular claiming strategies, File & Suspend and File & Restrict, allowed for this. However, File & Suspend has been eliminated while File & Restrict has one year left (eligible for those born by January 1, 1954). Keep in mind that spousal benefits can begin as early as 62 albeit at a reduced rate and you must be married for at least 12 months.
Taxation of Benefits
To the surprise of many, Social Security retirement benefits are taxable at ordinary income tax rates if your income exceeds certain thresholds. These thresholds are determined by your “Provisional Income” which is your modified adjusted gross income (MAGI) plus one-half of your Social Security retirement benefits. If you are single or married filing jointly with provisional income less than $25K and $32K respectively your benefits are not taxable. However, 50% of your benefits become taxable if you are single with provisional income between $25K and $34K or married filing jointly with provisional income between $32K and $44K. Once your provisional income is greater than these last two thresholds 85% of your benefits become taxable. Unfortunately, these thresholds were put in place forty years ago and they were never adjusted for inflation, which means more retirees will have to pay taxes on their benefits.
Social Security is important in almost every aspect of retirement planning, from the timing of benefit collection to the spousal benefit including ex-spouse and survivorship. Mistakes happen and are very common, however, the consequences of these mistakes can have lifetime ramifications. To make the most effective use of social security benefits it is important to work with your financial or tax advisor to plan the best course of action.
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