If you’re not 100 percent sure how to make the most of your Social Security benefits with your retirement plan, read on.
The first Social Security benefit was paid out in 1940 to a school teacher.1
Nearly 80 years later, 48 million retired Americans and their survivors receive the benefit.2 Yet some confusion still surrounds the claiming of Social Security for retirement income.
Below are answers to six key questions about Social Security benefits – to help you cut through all the confusion. Learn how your retirement income and pension can affect your benefits, whether you should count on your Social Security to subsidize your retirement, and more.
1. Can my retirement income impact my Social Security benefits?
Yes, if you earn greater than the 2018 income threshold of $17,040 and are less than full retirement age your Social Security benefits will be reduced. Note that once you reach full retirement age of 66 or 67, the money you earn at a job shouldn't affect your benefits.3
The earliest age you can receive Social Security benefits is 62. Some retirees decide that a job-free life isn’t for them and decide to return to work part-time. In fact, nearly one-third of people ages 65 to 69 were in the workforce in 2017.4
2. What happens if my employer was not required to withhold Social Security taxes from my income?
Many public sector employees don't have to pay Social Security taxes while working - rather that money goes towards the funding of public pensions. In addition, employees who work outside of the United States may not pay Social Security taxes. The Windfall Elimination Provision (WEP) describes how your Social Security benefits may be reduced.
3. Will a pension lower my Social Security benefits?
Pensions may lower Social Security benefits depending on whether your pension is from a private- or public-sector employer (i.e., public school or state/local government entity). Another factor is whether you paid Social Security payroll taxes during your career.
The WEP affects some three percent of Social Security beneficiaries, or 1.8 million people, who collect a pension in which they didn’t pay Social Security taxes. However, most employees pay these taxes — which amounts to 6.2 percent of gross wages — through FICA (Federal Insurance Contributions Act), and their employers match these contributions.5
Private sector vs. public sector
Employees in the private sector pay the 6.2 percent Social Security tax through payroll taxes, and their employers match it. So these employees aren’t penalized during retirement. Conversely, many public sector employees don’t have to pay Social Security taxes while working — rather that money goes toward the funding of public pensions; thus, the law requires that these employees’ Social Security benefits be reduced.
Note: If a public pension is in your future, be sure to plan the timing of when you claim both your pension and Social Security benefits — you might want to stagger them. Why? Because the rules that govern both are only effective when you’re receiving both at the same time.
For example, if you’re set to receive your public pension at age 62, you might want to wait to claim your Social Security benefits at a later age. On the other hand, private pensions generally don’t affect Social Security benefits.6
Also, keep in mind that your Social Security benefits won’t be reduced if your spouse collects a pension but you don’t.7
4. Is a retirement pension considered income?
For Social Security purposes, pension payments are not considered to be earnings so you won’t need to pay Social Security taxes. However, you may have to pay income tax on all or some portion of them.8
Fully taxable pensions would include ones that you didn’t contribute to, your contributions have been tax-free, or your employer didn’t withhold contributions. Partially taxable pensions include ones that you contributed after-tax dollars to. Lastly, if you receive a pension payment early (before age 59½), you might be taxed an extra 10 percent.9
5. What percentage of retirement income will come from Social Security?
Your Social Security benefit should be approximately 40 percent of your pre-retirement earnings.10
It was never intended to replace your entire income when you retire. So, your retirement income should be balanced and resemble a three-legged stool:
- Your Social Security,
- Your employer benefit program,
- Your personal savings/investments.11
Many financial experts say to you will need about 70 percent of pre-retirement earnings to maintain your standard of living after you retire.12 But if you plan to spend more money on travel and entertainment, then expect to save more for a higher cost of living. And keep in mind inflation.13
Most recipients receive between $700 and $1,800 in Social Security benefits per month. In 2016, Social Security benefits averaged $1,341 per month.14
Even people who earned very high salaries don’t make a fortune from Social Security. In 2017, the largest Social Security income payment was for $3,538 a month, which went to a retiree who waited until age 70 to collect his or her benefits.15
6. Will my Social Security retirement payout be enough?
It depends on many factors — including when you retire and start drawing Social Security.
Beginning in 2030, the government estimates the average payment to recipients will need to be cut by 29 percent. That’s because the number of workers (many of them retiring Baby Boomers) who contribute to Social Security is on the decline. For now, the Social Security Trust Fund is helping to make up the shortfall, but it can fix the problem for only so long.16
That means by the time you retire, you might not be able to count on Social Security replacing 40 percent of your income. Consider investing more in a 401(k) or an IRA to offset this balance.
This information is a general discussion of the relevant federal tax laws provided to promote ideas that may benefit a taxpayer. It is not intended for, nor can it be used by any taxpayer for the purpose of avoiding federal tax penalties. Taxpayers should seek the advice of their own advisors regarding any tax and legal issues specific to their situation.