For many people, their Social Security benefits are among the largest benefits that they take with them in retirement. As such, doing your research to ensure that you get the most out of this stream of income is very important. That is why we have compiled a list of five simple ways that you can maximize your Social Security benefit.
Before we jump into our list of how you can increase your benefits, let’s take some time to understand some basics about Social Security:
How It Works
Social Security is funded through what are commonly known as payroll taxes. If you take a look at your paycheck, it generally contains three separate categories of tax withholdings: Federal Income Tax, State Income Tax, and FICA taxes. FICA stands for Federal Insurance Contributions Act. FICA is split into two categories, OASDI (That’s Old Age, Survivors, and Disability Insurance) and Medicare. Each employee funds OASDI at 6.2% and Medicare at 1.45%. In addition to the 7.65% that employees are taxed, your employer is also taxed that same amount. This means that if you are self-employed, you get to pay 15.3% of all your wages for FICA taxes. At any rate, this means that for $100k of income $12,400 is paid on your behalf into Social Security and $2,900 is paid on your behalf into Medicare. These contributions, based on your highest 35 years (adjusted for inflation), are utilized to determine your benefit in retirement. This is important to note, because if you do not work a full 35 years, then a $0 benefit is entered in for those years. Additionally, Social Security is significantly skewed to replace a higher percentage of lower wage earners income. Your Social Security pays you based on your Average Indexed Monthly Earnings (AIME); in other words, it pays you the present value of your average earnings. For 2023, your Social Security Benefit at Full Retirement Age (FRA) is formulated to replace the following amounts of your AIME:
90% of the first $1,115
32% of the next $6,721
15% of any amount over $6,721 (up to the maximum earnings amount of $13,350).
In other words, if you are a low-income earner making an average of $12k/year (indexed for inflation) you will pay an average of $744 annually and receive $10,800 in benefits annually. Alternatively, if you are a relatively high-income earner and make $160k/year you will pay on average $9,920 annually while receiving $47,745.84 of benefits annually. Think of this as a kind of an inverse to our progressive income tax system. With income taxes, the more you earn, the higher your marginal tax rate. With Social Security, the more you earn, the lower your percentage of wages are replaced. In the example above while both pay 6.2% (not including employer contributions), the lower income earner has 90% of their income replaced while the higher income earner only has approximately 30% of their income replaced.
That’s Great but…How do I get the Most Out of It?
1. Work a Full 35 Years
As stated above, your calculation is based on your top 35 years of earnings. This means that years in which you have a $0 reported because you did not work have a disproportionate negative impact on your calculation. This DOES NOT mean that you need to keep working in your high paying, high stress job. Finding a lower paying or part time job that is less stressful can be a great solution if you do not have a full 35 years of working history.
2. Delay Getting Benefits
As the law currently stands, your full retirement age is between 66 and 67 based on what year you were born. However, this does not mean that is when you are required to take your Social Security. You can take your Social Security retirement benefit starting at age 62 and can delay all the way until age 70. For each year prior to your Full Retirement Age (FRA), your benefit is reduced from 5-7% each year and for each year you delay receiving your benefit beyond your FRA, your benefit is increased by 8%. In other words, if your benefit at your FRA of age 67 is $1,000, your benefit would be reduced to $700 if you started receiving it at 62 but would be $1,260 if you waited until age 70; a difference of $560 per month.
3. Understand the Earnings Test
This one is a bit of a corollary to #2, but in addition to receiving benefits prior to your FRA and thereby reducing your benefits, there is also a built-in penalty for those who earn too much money while receiving Social Security benefits before their full retirement age. For 2023, individuals who are receiving Social Security retirement benefits prior to their FRA and earn more than the earnings test amount of $21,240 are penalized on every dollar above this cap.
4. Understand your Spousal Benefit
The spousal benefit allows spouses to receive 50% of their spouse’s benefit at FRA in place of receiving their own Social Security benefit. This is especially important for those families in which one spouse stayed at home to raise children or there is a large discrepancy between the earnings of each spouse and also includes ex-spouses if the marriage lasted for 10 years or more. This rule does lend itself to some more complicated strategies, however those are beyond the scope of this blog. One large caveat to this is you must wait until your spouse has applied for his or her benefit to apply for the spousal benefit.
5. Understand Survivor Benefits
There is a surprisingly large number of survivor benefits associated with Social Security, however for purposes of this blog we will focus on what happens to Social Security benefits when you or a spouse passes away. Simply stated, when you or a spouse passes away you only get to keep the bigger of the two. This generally means that the best strategy is to delay pulling Social Security until age 70 for the larger of the two benefits as a way to maximize income for the longer surviving spouse. Much like understanding your spousal benefit, this rule lends itself to some more complex strategies that are beyond the scope of this blog. While not intuitive, it is extremely important to keep the survivors benefit in mind when making your claiming strategies.
The decisions around Social Security are among the most impactful financial levers you pull in your lifetime. Understanding how to get the most out of your benefit not only reduces financial stress but also can lead to a happier and healthier lifestyle in your retirement years. Due to the nature of Social Security claiming, there is a lot of pressure to get this decision right. If you or someone you know would benefit from working with a professional to determine the best Social Security claiming strategy for you, schedule a call today.
This post is for educational and entertainment purposes only. Nothing should be construed as investment, tax, or legal advice.