Social Security: What You Don’t Know Could Cost You
By Bill Leavitt
Have you ever calculated how much you’ve been paying into Social Security throughout your working years? You’ve been contributing to Social Security your whole life, right back to your first official paycheck. Between you and your employers, you’ve doled out 12.4% of your annual income. That’s a substantial amount, and one that could make your 401(k) look like chump change down the road. Don’t you want to maximize your benefits so you get every penny that’s rightfully yours?
Unfortunately, Social Security is complicated and often misunderstood. Many people make incorrect assumptions or get intimidated by the details, but not properly understanding the system and how your benefits work could be financially devastating. Let’s look at some common Social Security assumptions and set the record straight so you don’t leave money on the table.
Myth #1: Social Security Is On Its Way Out
There have been rumors floating around for years that Social Security won’t be around by the time we reach retirement. Here are the facts: Social Security trust funds have been running a surplus since 1982. Right now, the surpluses are predicted to stop in 2020 and the system will rely on incoming interest payments to make up the deficit until 2035. At that point, if no changes are made, benefit payments may shrink to 80% of what Americans expect. (1)
Unfortunately, you can’t control whether the Social Security program fails or succeeds. Your best bet is to educate yourself and plan accordingly. Create an account on the Social Security website so you can stay on top of your current benefits and know where you stand. There is plenty that could happen between now and 2035 that could impact the program, so don’t believe the assumption that there will be no money left for you by the time you retire.
Myth #2: Social Security Is Like A Savings Account
Since you and your employer are contributing a hefty amount to Social Security each paycheck, it’s easy to see how many people think it’s like a savings account, where the money you contribute is the money you receive. But it’s not. What actually happens is that taxes pulled from individual paychecks are pooled together and used to support those currently receiving benefits. Your contributions are supporting retirees, and when you retire, the money others pay into the system will support you.
In 1960, the number of contributing workers-to-beneficiaries ratio was 5:1. (2) The most current data tells us it is now 2.8:1, with a prediction of 2.2:1 in 2035. (3) So while the number of workers paying Social Security is decreasing, there are still more paying in than receiving benefits. As time goes on and the life expectancy of our population increases, you may need to mentally prepare for your benefits to be less than what you thought they would be.
Myth #3: Everyone Contributes Equally To Social Security
Everyone pays 6.2% out of their paychecks to fund Social Security (with their employer paying another 6.2%), with an earnings cap of $132,900. If you earn that amount, and your neighbor earns $5 million, you will both pay the same Social Security deduction of $7,960.80. (4) If this earnings cap was eliminated, it’s estimated that 71% of the trust fund shortfall could be wiped out.
Myth #4: You Should Claim Social Security At Age 65
Social Security benefits can be claimed anytime between ages 62 and 70. However, the timing of when you choose to collect these benefits will impact the amount you receive.
Full retirement age (FRA) changes based on the year you were born. For those born before 1943, FRA was 65 years. For those born between 1943-1954, FRA is 66 years. Starting in 1955, two months a year is added until the FRA becomes 67 for those born in 1960 or later. (5)
If you wait until reaching full retirement age to begin collecting Social Security benefits, you will receive your full Primary Insurance Amount (PIA), which is the full benefit you have earned. If you decide to collect early, your benefit will be reduced by 6.67% per year until your FRA, up to three years. (6) Beyond that, the benefits will be reduced by 5/12 of 1% per month. Remember that the earliest you can collect Social Security retirement benefits is age 62.
Myth #5: Your Benefit Amount Is Fixed
As we just learned above, collecting your Social Security benefits before you reach your full retirement age will result in you forfeiting a percentage of what you have earned and accepting a lower payment. This is obviously before consideration of the additional years you would be getting the decreased benefit. Nevertheless, did you know that for every year beyond your FRA that you delay taking benefits, the value increases by 8%, all the way up until age 70? There is nowhere else you can get an 8% return guaranteed by the U.S. government! (7) This means that your benefit amount is not fixed, and depending on when you begin to collect, you will either leave money on the table, receive exactly what you’ve earned, or even make out with some extra.
Myth #6: Earning An Income Will Not Affect Your Benefits
This is one of those myths that is partly true. Once you reach full retirement age (FRA), it is true that your benefit amount will not be affected by your other income. However, that changes if you begin collecting your benefit while below your FRA and have another source of income. There is a set limit that, when surpassed, your benefit is reduced.
For 2019, that limit is $17,640 if you are not yet in the year in which you reach FRA. For every $2 you earn above $17,640, your Social Security benefit will be reduced by $1. During the year that you reach FRA, the limit is $46,920. When you exceed that during your FRA year, your benefit will be reduced by $1 for every $3 you earn. (8) Then, as soon as you reach FRA, all limits are lifted. You can earn as much as you want and it will have no effect on your Social Security retirement benefits. These benefits are not “lost,” however. If your benefits were reduced because you earned too much prior to reaching FRA, you will get these benefits back when your payment is recalculated to account for the reduction associated with excess earnings.
Myth #7: You Can Change Your Mind
A shocking 38% of people incorrectly believe they can simply switch their claiming strategy with no repercussions after they’ve made their official choice. The truth is that you can withdraw your claim and reapply at a future date, however, this is not done without consequence. (9)
The Social Security website states that you may withdraw your claim only once within your lifetime, and it must be done within 12 months of the original date you applied. Furthermore, you must repay all the benefits you and your family received, including all benefits your spouse or children received, whether they are living with you or not. (10) If you miss that 12-month window, you can suspend your benefits, but only if you have reached FRA but have not turned 70.
Myth #8: Your Claiming Strategy Affects Your Ex-Spouse
Many people don’t realize that their ex-spouse’s claiming strategy has no bearing on their own benefits. With that being said, there are criteria that need to be met in order to be able to claim benefits based on an ex-spouse’s record. You must have been married for 10 consecutive years, have not remarried (unless your later marriage has already ended by annulment, divorce, or death), and have divorced at least two years before applying. If you meet these criteria, you are entitled to either your full benefit or up to half of your former spouse’s benefit, whichever is greater. (11)
Myth #9: You Can Receive Your Benefits Whenever You Want Them
Social Security, like most other complex programs, requires some time to process and begin. It is generally recommended that you file for benefits around three months before you need your first payment. However, your application can only be processed a maximum of four months before benefits are scheduled to begin. This means that if you are planning on starting as soon as you are eligible, at age 62 and one month, you cannot apply before you are 61 years and 10 months old. (12) Keep in mind that your first benefit payment will always be 1 month behind the start date. Therefore, if you apply in order to start your benefits at 65, you will get your first check in the first month after your requested start date, at 65 years and one month.
Myth #10: Social Security Is A Headache
While it may seem like there is a lot of stress involved with making sure you optimize your Social Security benefit, the fact is that Social Security remains a major piece of your retirement puzzle. It was designed to replace 40% of an average worker’s wages, and that’s money you don’t want to miss out on. However, there is no one-size-fits-all claiming strategy, so it’s critical to work with an experienced professional who can provide you with confidence and make the whole process much less overwhelming.
Get Your Information From The Right Source
Our goal at Bridgelight Financial Advisors is to help those who are planning for retirement develop a personalized financial plan to take command of their wealth. We believe that an integral part of this plan is your Social Security benefits. We work hard to educate you on your opportunities, answer your questions, and offer objective guidance.
If you are preparing for retirement and want to partner with someone who is passionate about helping you maximize your Social Security benefits and pursue your ideal retirement, call (203) 795-7080, email Advice@BridgelightAdvisors.com, or schedule an appointment online!
Bill Leavitt is the president of Bridgelight Financial Advisors, an independent, privately owned financial advisory and financial planning firm. He specializes in working with pre-retirees, retirees, professionals, and women investors, helping them navigate a complicated and ever-changing investment landscape. With over 25 years of experience, Bill serves his clients using his own unique financial planning model, The Wealth Focus™ Process, where he helps clients develop their customized long-term wealth strategy in four comprehensive steps. A Connecticut native, Bill resides in southern Connecticut with his wife, Laura, and their three daughters. To learn more about Bill, connect with him on LinkedIn.