What will you live on when you quit working? Ideally, you have been socking away money that will grow into a well-funded nest egg to keep income flowing, but you’re probably also expecting to receive some money from the government in the form of Social Security.
The very name of this program is intended to make us feel, well, secure. And that’s the point: It is designed to ensure we all have funds available to spend on food and necessities when we retire, or if we should become disabled or lose your spouse, provided we’ve paid into the system as a worker.
Let’s dig in to the dollars and sense of Social Security to figure out what it is and why it’s so important.
Social Security is often referred to as a “safety net” for retirees and the disabled, along with the families of the retired, disabled or deceased (with certain restrictions). Employees have a Social Security tax taken out of their paychecks now with the idea that they will benefit from Social Security themselves down the road. According to the National Academy of Social Insurance, about 169 million Americans currently pay into the Social Security system, with approximately 61 million collecting monthly benefits—the group estimates one-quarter of American families receive income from Social Security.
The program is known as “pay-as-you-go” which means that today’s workers are funding benefits for today’s recipients; in other words, your money is not sitting in an account waiting for you (and, yes, that’s why you should be investing your money, too, in order to ensure you have your own retirement account with your name on it).
That set-up is precisely why Social Security is such a hot topic, as prognosticators anticipate there will one day be more people collecting money than paying into it. But before we look at its future, let’s explore where it came from and where it is today.
For the birth of the Social Security system, we go back to the Great Depression, and President Franklin D. Roosevelt’s efforts to stabilize the country’s economy through the “New Deal” programs. He introduced what he called a “plan for social insurance as a safeguard against the hazards and vicissitudes of life" and signed the Social Security Bill into law on August 14, 1935.
Originally designed just for the primary worker, the program added survivor benefits and benefits for the retiree's spouse and children in 1939 and disability benefits in 1956. Then in 1965, President Lyndon Johnson added another component to the Social Security program with Medicare, a health insurance program for those 65 years or older, or those younger than 65 with certain disabilities.
The original age to collect benefits was 65, based on life expectancy at that time, but as we live longer, the program has been updated to push out the age when you start collecting benefits.
Today, the program has a variable timeline—you can start taking reduced benefits as early as age 62, but your “full retirement age,” when you receive 100 percent of your Social Security benefits, is currently age 67 for those born in 1960 or later. But if you wait until age 70 to start collecting, you get a “bonus,” called “delayed retirement credits.” In other words, the longer you wait to collect, the more you will collect each month.
You started paying into Social Security with your very first paycheck. If you are a “W-2 employee”—that is, you receive compensation from an employer—your paycheck will reflect your Social Security “withholdings,” known as the Federal Insurance Contributions Act or FICA.
You’ll pay 6.2 percent into the fund, and the good news is that your employer is covering 6.2 percent also, for a grand total of 12.4 percent of your income that you are personally responsible for. Once you hit $132,900 in compensation (as of 2019), you stop paying into the Social Security fund, although you will continue paying into Medicare regardless of how much you earn.
If you’re self-employed—that is, you receive a 1099 as in independent contractor, rather than a W-2— you are responsible for the entire 12.4 percent, meaning which you have to contribute the employer’s match as well as your own. (Yes, being your own boss does have a small downside!) Instead of the funds being automatically withheld, as they are when you receive a paycheck, you’ll need to pay it yourself when you file your annual income taxes or make estimated tax payments.
You’re probably also wondering how you get the payments out. In order to qualify for Social Security, you need to amass 40 Social Security work “credits.” Each quarter that you earn at least $1,360 (as of 2019) counts as a credit, so it’s essentially equal to 10 years of steady work. Your credits never expire, so if you put in five years, then take a two-year break, those credits are waiting for you.
Eventually, your Social Security benefits are calculated based on factors such as your income, the year you were born and the year when you start receiving benefits.
Each year the Social Security Administration offers a modest cost-of-living-adjustment, and we do mean modest. For example, if you were on Social Security today, you would have received notice that there is a whopping 1.6% “raise” coming in 2020.
When you think of Social Security, you think of retirees, but there are other groups who are also able to reap its benefits.
Spouses who haven’t worked enough to qualify for their own Social Security benefits are eligible to receive up to one-half of their spouse’s benefits if they are at least 62 (and the spouse is also receiving retirement or disability benefits) or if they are caring for a child who is under 16 or disabled and is receiving benefits. If you are divorced but were married for at least 10 years, you may be able to collect benefits based on your former spouse’s earnings if you haven’t married again, and your former spouse is entitled to benefits.
If you become disabled but worked long enough to accrue Social Security benefits, you would qualify for Social Security disability. A separate program, Supplemental Security Income (SSI), is based solely on need rather than your earnings, and covers benefits to disabled adults and children who have limited income and resources.
Spouses and dependents are typically eligible for benefits, based on the earnings of the person who died. This chart offers examples of the benefit percentages you may receive based on your relationship to the deceased, along with some caveats, including income limits.
And there are some groups that likely won’t receive Social Security, such as those who haven’t paid in enough credits; self-employed workers who don’t claim their income on their taxes; and some employees who work for federal, state or local governments and therefore receive a pension instead.
You’d think you wouldn’t need to sign up for Social Security until you start working, but it’s actually part of a new parent’s financial checklist. So most of us get a Social Security number when we’re still babies. That’s because parents need that number to claim the child as a dependent on their income tax return or open a bank account in their name. (Fun fact: the Social Security Administration uses these Social Security applications to develop an annual list of the top 10 baby names. Liam and Emma took the top spots in 2018.)
And then of course, the number becomes ultra-important as soon as you get your first job. As anyone who’s gotten a paycheck knows, that’s when FICA starts taking a bite out of your earnings.
It’s important to safeguard your number as it is an easy way for a fraudster to commit identity theft. Unless someone absolutely needs it—such as an employer or bank—see if you can offer an alternate form of ID, like a driver’s license number. You shouldn’t use your Social Security number as a password and don’t carry your card with you.
Additionally, it’s wise for parents to check their child’s credit report—even if they think they don’t (and shouldn’t) have one—as a precaution to make sure someone isn’t falsely using their identity.
Social Security is an important program that helps prevent many people from slipping into poverty. But, remember that Social Security is only designed to replace about 40 percent of your pre-retirement income, on average. (It will replace less of a high earner’s income and a higher percentage for someone who earns less.)
And the future of the program remains uncertain—according to current estimates, Social Security’s trust funds are set to run out by 2035, which means that only 80 percent of promised benefits will be payable. Lawmakers are constantly working on program reform; for example, the Social Security 2100 Act is currently under consideration, but no fixes are certain.
That’s why it’s great to hope that you will ultimately be able to collect Social Security benefits, but it’s prudent to save for retirement in other ways, too, to supplement those expected funds.
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