Deciding when to apply for Social Security benefits is one of the most important (and most daunting) decisions a person will make in their life. With the release of the Social Security Administration’s Trustee’s report last week, it’s only appropriate to examine seven commonly held myths about this complex government program:
Myth 1. The Social Security tax withheld from your paycheck goes into a personal account.
Uncle Sam does not put your tax money into a personal account for your retirement. Although there is a trust fund, Social Security is largely a pay-as-you-go system. The taxes you pay today are given to beneficiaries that are currently retired. Tomorrow’s workers will (presumably) pay the benefits of today’s younger Americans, when they reach retirement age.
Your highest 35 years of wages are used to calculate an average index of monthly earnings; this is then used to calculate a primary insurance amount, or the monthly benefits you would receive at your full retirement age. That amount is paid to the retiree by way of Social Security tax revenue collected from present workers.
Myth 2. People who haven’t worked can’t collect Social Security benefits.
What happens to stay-at-home parents? If they haven’t worked, then their highest 35 years of income is technically $0.
Because of this, people have the misconception that individuals who don’t work can’t collect Social Security benefits. However, at the age of 62, a person can qualify to collect benefits equal to their working spouse’s. People can even collect spousal benefits after getting divorced, as long as they are at least 62 years of age, were married to their ex-spouse for at least 10 years and have been divorced for 2 years, and are currently unmarried. Survivor benefits are also an option for surviving spouses starting at the age of 60.
Myth 3. You should start collecting benefits as soon as possible.
Not necessarily: Depending on their date of birth, people have a full retirement age between 65 and 67 years. This is the age where people can receive 100 percent of their benefits. The earliest age at which a person can apply for benefits is 62, but this results in a 25 percent reduction in monthly benefits, since they are applying for benefits early.
Delaying benefits past full retirement can earn a retiree delayed credits that can increase their benefits even further: A person who applies for benefits at the latest possible retirement age of 70 can gain an 8 percent increase in monthly benefits, giving a person more than their primary insurance amount. If a person is concerned about wealth longevity, waiting to apply for benefits may be the best course of action.
Myth 4. Social Security benefits will fully support your post-retirement lifestyle.
Wouldn’t that be nice! Unfortunately, that’s not what Social Security is intended to do. According to the Social Security Administration, Social Security is only supposed to ensure that retirees live above the poverty line. Benefits replace about 40 percent of a person’s pre-retirement income, and could potentially replace a little bit more if a household’s income is relatively low. Most financial advisors suggest that retirees have other forms of income (such as investment returns and pension plans) equivalent to 70 percent of their working wages.
Myth 5. You can’t earn benefit credits after retiring.
A retiree who decides to continue working after applying for benefits will have those working credits calculated into the next year’s primary insurance amount. If a person is working after retiring and earns one of their highest 35 annual indexed-earnings, then this year will be used to recalculate their benefits. But, as discussed in the next myth, there is a catch to working while collecting benefits.
Myth 6. You can spend your entire Social Security check because benefits are not taxable.
Uncle Sam always gets his cut of the pie, and Social Security is no exception. If half of a retiree’s benefits, combined with all other sources of income, exceed a base level set by the IRS –$25,000 for singles and $34,000 for married couples – then their benefits will be taxed. Up to 85 percent of a person’s benefits can be taxable depending on their total household income (ouch!).
Myth 7. Your benefits are fixed regardless of inflation.
Wage rates in the 1950s do not have as much purchasing power today: Everyone can agree with that, including the government. Because of this, benefits are increased each year using the Cost of Living Adjustment (COLA). The Consumer Price Index is used to increase benefits every year.
Accuracy is the key to a successful retirement. Being an informed retiree leads to more sound retirement decisions and can result in maximizing one’s benefits. For more information about Social Security, you can visit the Social Security Administration’s website at www.ssa.gov.