Curious about your Social Security benefits? Not sure what it all means? Like with most government programs, understanding the Social Security system and how it all works can be hard.
There are many things the average American is unaware of when it comes to Social Security. And the possibility of paying taxes on it is one of them.
Yikes! The dreaded "T" word!
But no worries! You've come to the right place. We're going to breakdown Social Security and help you determine how much money you can expect from it in retirement.
We'll also take a peak at cases when you will have to pay taxes on your Social Security benefits as well as look at some ways in which you can decrease (or avoid!) those taxes.
Though the Social Security system may some like the twilight zone, this post will break it all down for you. We'll dispel some myths and confirm some truths. Starting with, what exactly is Social Security?
What is Social Security?
Social Security is a social insurance program that provides monetary benefits to retirees, people with disabilities, and survivors such as widows/widowers.
It is administered by the United States Social Security Administration (SSA) which was created in 1935. Social Security is the largest social welfare program in the US with almost 70 million people receiving benefits in 2019.
If you have worked in the US or for a US company for a certain length of time, you should be able to receive benefits once you reach retirement age.
Your Social Security benefits is dependent upon your average monthly income with adjustments for average income growth.
How it Works:
To fund your retirement benefits later, you pay Social Security taxes from your earnings now. Then, when you retire, you receive those benefits in the form of a monthly stipend.
The amount you receive depends on the amount you put in. And what you put in, is based on your income. So each time you receive a check you pay taxes on it into your Social Security.
Your Social Security benefits is dependent on factors such as when you decide to retire, your spouse, and if you have a pension.
The Calculations
The way your payout is calculated is based on your earnings. The SSA takes percentages of your earnings then adds them together to arrive at your Primary Insurance Amount (PIA).
Later, they will increase or decrease your PIA depending on when you retire, whether you have a pension, etc. Then they will add to (or subtracted from) your PIA to arrive at your Social Security Benefit amount.
See the chart below for the percentages of earnings used to arrive at your primary insurance amount.
Income | Percentage |
|---|---|
up to $996 | 90% |
$996 - $6,002 | 32% |
> $6,002 | 15% |
To Qualify:
To be eligible to receive these Social Security benefits however you will need to have enough work credits.
Depending on how much you make in a year, you could receive up to 4 work credits annually. To be insured, you must receive at least 1 work credit per year from age 21 to 62 with a maximum of 40 work credits.
To qualify for disability, you need at least 20 work credits in the last 10 years if you are 31 or older. If you are younger than 31, you don't need as many credits.
Things to Note:
The thing to note here is that while most companies participate in the Social Security program, there are some who do not. If your job is not covered by Social Security, you won't be able to participate nor receive Social Security benefits later.
Furthermore, your benefits may be reduced if you work for a company that provides a pension and if you've worked some time in a job covered by Social Security and some time in a job not covered.
Windfall Elimination Provision
The Windfall Elimination Provision (WEP) is a formula used to adjust your Social Security benefits if you will also be receiving a pension.
It was made to prevent the unintended advantage of someone getting a higher percentage of their income in Social Security benefits because, in the system, it looks as if they were long-time, low-wage earners.
When It Applies:
- You turned 62 after 1985
- OR You became disabled after 1985 and you turned 62 after 1985.
- You are in the Civil Service Retirement System (CSRS) (After 1956)
If you paid into Social Security for less than 30 years and you will also be getting a pension, the SSA will reduce the amount of your Social Security benefits according to the chart below.
The WEP formula reduces the 90% factor in the earlier table to ensure that the payout received is fair.
WEP Reduction Chart
Number of Years Paid Into Social Security | New Percentage |
|---|---|
29 | 85% |
28 | 80% |
27 | 75% |
26 | 70% |
25 | 65% |
24 | 60% |
23 | 55% |
22 | 50% |
21 | 45% |
20 or less | 40% |
To see the maximum amount they can deduct from your benefits check out their chart here (scroll to bottom).
However, if you paid into Social Security with substantial earnings for 30 years or more, the WEP does not apply to you and you will receive full benefits.
Furthermore, WEP doesn't apply to survivors benefits, federal workers hired after 1983, non-profit employees that were exempt as of 1983, people whose only pension is from railroad work.
Things to Note:
One thing to note is that deductions are taken out before they apply early retirement deductions, delayed retirement credits, or cost of living adjustments.
Be aware though that the maximum deduction you can receive on your benefits is limited to half of your pension no matter what the chart says.
The WEP also affect expats who may have a pension in another country.
Government Pension Offset
The Government Pension Offset (GPO) rule was passed in 1977 with amendments made to Social Security to prevent people who have pensions (and did not pay into the system) from getting more Social Security benefits than those who did.
It affects spouses, widows, and widowers who are federal, state, and local employees with pensions that did not pay into Social Security. As a result, the SSA reduces their benefits by 2/3 of their pension.
There are some cases where GPO does not apply.
- The pension you receive is not based on earnings
- Your pension is from a job in which you paid Social Security taxes (includes Civil Service Offset, CSRS employees insured by Social Security) AND
- Your last day of employment is before July 1, 2004 OR
- You filed for and were entitled to spousal/widow(er) benefits before April 1st, 2004 OR
- For the last 60 months of government work you paid Social Security taxes. (If those last months were between June 30, 2004 and March 2, 2009, it may be okay to have less than 60 months)
- You received, or were eligible for, your pension before July 1, 1983 and was receiving 1/2 support from your spouse.
- Met all requirements for Social Security spousal benefits in 1977 and received, or was eligible to receive, your pension before December 1982.
- You switched from CSRS to Federal Employees' Retirement System (FERS) after December 31, 1987. AND
- Your last day of service was before July 1, 2004
- You paid the taxes for 60 months and reached retirement age after January 1988
- You filed for and were entitled to spousal/widow(er) benefits before April 1st, 2004
Who is not covered by Social Security?
There are a number of groups not covered by Social Security. If they do not participate in Social Security they must have their own employer-sponsored plan or way of taking care of their elderly.
The first of these groups not covered by Social Security are some religious groups who have elected not to participate in the program. They often see participating in the program as gambling. These groups include the Amish and the Mennonites.
There are also many state and local government workers not covered by Social Security such as teachers and police officers.
That is usually because their employer has a defined benefit pension plan instead which should replace the Social Security benefits with benefits that are at least equivalent.
Others that may not be eligible for Social Security include some family employees and some students.
Railroad workers are covered by the Railroad Retirement Board not Social Security but they can still receive Medicare.
When can you receive Social Security?
You can begin to receive your Social Security benefits anytime after you turn 62 years of age. Although 62 is not considered full retirement age by the SSA, they allow you to start receiving your benefits early.
By doing so your benefits will be reduced accordingly. The maximum reduction you'll receive is a 30.1% deduction to your payout.
Full Retirement Age:
- Born 1943 - 1954 = 66 years of age
- Born 1955 - 1960 = Gradual increase by 2 months until it reaches 67. So if you were born in 1959, your full retirement age would be 66 and 10 months.
- Born after 1960 = 67 years of age
Note: If you were born after 1929, you can only be eligible to receive Social Security benefits once you have 40 work credits which is usually 10 years of work.
How much do you pay into Social Security?
As of now, you are taxed 6.2% of your income while your employer pays the other 6.2% for Social Security. If you are a self-employed individual, you will have to pay the full 12.4% yourself.
The SSA sets a limit on how much of your earnings they tax though. For 2021, the cap is $142,800. This tends to increase every year.
Sidenote: Medicare taxes are also taken out of your income. Those are 1.45% for both individual and employer and 2.9% for people who are self-employed.
What are your Social Security benefits? And how do you calculate them?
Everyone who pays into the Social Security system for a sufficient amount of time are entitled to Social Security benefits. This means you will get money each and every month to help you afford your retirement.
Your benefits will not be the same as others as SSA factors in whether you are still working, have a pension, where you live, marital status, etc.
According to SSA, people receive on average about 40% of their pre-retirement income in benefits. So, if you were making $50,000 for the past 10 or however many years, your Social Security benefit would be $20,000 a year (or $1667 a month).
To get a good estimate of what you can receive during your retirement check out the SSA's retirement estimator. You can get a more personalized estimate by setting up your own My Social Security Account.
Early Retirement Deductions
If you decide to retire early (i.e before age 67), your Social Security benefits will be reduced. You can retire starting from age 62. At which point, your monthly benefits will be reduced to 71.7%.
As you retire later and later that percentage will be increased, until you reach the full retirement age of 67 and receive 100% of your Social Security benefits.
If you are curious the reductions work as follows:
- up to 3 years before full retirement age, deduction = 5/9 of 1% for each month early
- for more than 3 years before there is an additional deduction of 5/12 of 1% for each month
Don't worry if this sounds like too much of a headache to calculate yourself. They have nifty calculators (scroll down) on the SSA site that you can use to determine what your Social Security benefits will be.
Delayed Retirement Benefits
By delaying your retirement until up to 70 years of age, you get extra benefits in the form of an increase in the amount of your monthly payments.
After 67 you get an 8% yearly increase in your Social Security benefits for each year delayed. If you decide to delay it by just a few months, you would get a monthly increase of .667% added to your benefits. (For those born after 1943).
For instance, should you decide to start your benefits at the age of 70 on your birthday, you will get a 24% increase in your benefits. This is the maximum amount that you can get.
Note: If you do decide to delay your retirement, make sure you sign up for Medicare at age 65. Your benefits may be delayed and cost more if you don't.
The maximum amount you can receive for delaying your benefits is 124% of your original Social Security benefits.
Social Security Benefits For Your Family
The members of your family can also receive benefits from your Social Security even if they have never paid into the system. These family members include your spouse, former spouse, and children.
Each family member may be able to receive up to 1/2 of your benefits each month. Thankfully, the benefits they receive does not affect your Social Security benefits.
Although the benefit amount changes depending on your family situation, the SSA pays a maximum of 150% to 180% of your benefits to your family. And it pays to know that your divorced spouse's benefits will not affect yours.
Spousal Benefit
If you are receiving your Social Security benefits (either from retirement or disability), you spouse is eligible to receive their spousal benefit if they are 62 years of age. At age 65, they can also receive Medicare benefits.
If your spouse qualifies for their own Social Security benefits, they will be paid that first. Then should your benefits be greater, the SSA will add extra to your spouse's benefits so that it is equal to yours.
Of course, if your spouse is working at the time, their earnings will affect how much money they can receive. But by working, they could increase the amount of benefits you and your family can receive.
Things to Note:
One thing to note is that spousal benefits don't include any delayed retirement credit you've racked up. Also, if your spouse retires before retirement age, their spousal benefits will be permanently reduced.
The reduction is 25/36 of 1% for each month that is early for the first 3 years. If he or she retires more than 3 years early than an additional 5/12 of 1% is taken out each month.
The SSA refuse to make these calculations easy, eh? Luckily, they have a calculator you could use. (scroll down)
Can you work and still receive Social Security Benefits?
Yes, you can work and still receive Social Security benefits. However, there is a limit to how much you can earn and still receive full benefits.
That limit has been set to $18,960 for the year 2021 if you are younger than the full retirement age. So if you make more than this for the year AND you have retired early, they will reduce your benefit $1 for every $2 over that you earn.
For the year when you reach full retirement age, they will only reduce your benefits $1 for every $3 over. Plus, the SSA raises the earnings limit to $50,520 (for 2021). And they only count your earnings up to the month before your birthday.
But, when you reach full retirement, however much you earn won't affect your Social Security benefits. Furthermore, if your benefits had been reduced or withheld because you made too much, the SSA recalculates your benefits and give you credits for that time.
The Special Rule for Those Filing For Benefits Mid-Year
If you file for your Social Security benefits mid-year and your earnings are over the limit, the SSA has a special rule where they can still pay you your full benefits for any month that you are considered "retired".
If you retire before full retirement age mid-year, you can still receive full benefits for any month in which your income is $1,580 or less. Even if, for the year, you earned more than the limit.
However, if you quit your job and started your own business, there are restrictions on the number of hours you can work in your business and still receive benefits.
You cannot work more than 45 hrs per month on your business. And if your business is in a highly skilled industry, you cannot work more than 15 hours per month.
Other factors that affect your Social Security Benefits
We've already talked about how your retirement age and whether you have a pension or not can affect the amount of benefits you receive. But there are other factors that can have an affect on your benefits that you should know about.
Your Spousal Benefits
If your spouse receives benefits that are higher than yours, you will get an additional amount added to your Social Security benefit so that it equals the higher amount.
Cost of Living
Every year the SSA makes adjustments for inflation and the increased cost of living. For 2021, that increase is 1.3%. This is the additional amount that will be added to your Social Security benefits.
Your Job Type
There are a few job types that have special rules when it comes to qualifying for Social Security and receiving Social Security benefits.
Here are a few of them:
- Self-Employed: Must file taxes and pay Social Security tax if you make more than $400 in a year (even if you don't owe taxes)
- Farm Work: Eligible to be insured if you get at least $150 in wages or if your employer has reported expenses of $2,500 or more to the IRS. (Seasonal Workers must commute daily to work, work less than 13 weeks, and be paid on a piece rate basis)
- Expats: You can use foreign work credits to qualify for partial Social Security benefits. It is possible to receive benefits from more than one country.
- Federal Government Workers: (Before 1984) If you are a part of the Civil Service Retirement System (CSRS), you did not pay into Social Security and so won't receive benefits. After 1983, if you joined the Federal Employees Retirement system, you will receive benefits. Your CSRS pension may affect payout.
- Household Workers: If you made $2,300 or more in 2021, you are eligible for Social Security and your employer must take out the taxes for it. Doesn't apply if you are under 18 and it is not your main job.
- Military: You get your full Social Security benefits even with your military pension. Also, if you had active duty from 1957-2001, you get special extra earnings added to your earnings record. Furthermore if you were in the military from September 16, 1940 - 1956, you may be eligible to receive special extra earnings credit of $160 per month.
- Non-Profits or Religious Organizations: If you make $100 or more, you must pay into Social Security with the self-employment tax rate of 15.3% (includes Medicare). Should you receive a pension from your organization, it may affect your Social Security benefits.
- Railroad Workers: To qualify for Railroad pension must have 10 years of work on the railroad or have worked 5 years after 1995. If you don't qualify for the pension, your earnings will go towards Social Security.
- State and Local Government workers: If you are covered only by a pension plan, you won't receive Social Security benefits for those wages and it may affect your other benefits/Social Security spousal benefits. You may have both a pension and a Social Security plan in which case you can receive Social Security benefits.
Deciding to Continue to Work
This works pretty much the same as deferring your retirement year. By continuing to work even during retirement and while receive Social Security benefits, you can increase your payout later.
This is because if your earnings are great enough, SSA will withhold some of your benefits until a later date.
Do you have to pay taxes on Social Security?
The short answer: maybe.
Whether you have to pay taxes on your Social Security benefits depends on how much you are earning per month. Once you pass the threshold, you have to pay taxes on a portion of your Social Security benefits.
These thresholds set by SSA are very low so chances are you will be paying taxes on your benefits. But never fear there are ways you can try to reduce the amount of taxes you pay.
We will look at a few of those a bit later but for now take a look at the tables below and see if you will have to pay taxes or not.
Up to 50% of Your Social Security is Taxed
Filing Status | Combined Income |
|---|---|
Single / Head of Household / Qualifying Widow(er) | $25,000 - $34,000 |
Married Filing Jointly | $32,000 - $44,000 |
Married Filing Separately (living apart) | $25,000 - $34,000 |
Up to 85% of Your Social Security is Taxed
Filing Status | Combined Income |
|---|---|
Single / Head of Household / Qualifying Widow(er) | < $34,000 |
Married Filing Jointly / Qualifying Widow(er) | < $44,000 |
Married Filing Separately (living together) | Any Amount |
Married Filing Separately (living apart) | < $34,000 |
Because the threshold for paying taxes is so low, you will most likely have to pay taxes on your Social Security benefits.
How do you avoid or reduce your Social Security taxes?
Whether your Social Security benefits are taxed or not is based how much money you have coming in every month. This includes income received from a part-time job, dividends and interests, pension payments, and withdrawals from your IRAs/401ks.
The best way to avoid the Social Security tax would be to make sure your monthly income (including your Social Security benefits) is below the threshold set by the SSA.
Unfortunately, this threshold is so low that it is quite likely you will not be able to avoid paying the taxes on your Social Security benefit. But, even if you can't avoid the taxes, there are steps you can take to reduce them.
Let's look at some ways in which you can do so.
1. Save in a Roth IRA or Roth 401k
A great way to reduce your Social Security taxes is to save loads in your Roth IRA or Roth 401k. This is because when you withdraw from these accounts your money is tax-free!
So max out those Roth accounts.
And bonus point good news, if you save enough in these accounts you may even be able to avoid paying taxes altogether!
2. Consider Doing a Back-Door Roth IRA
If you have a traditional IRA or 401k, you may want to consider doing a Back-Door Roth IRA before you retire. Essentially, this is moving money from your IRA or 401k to a Roth IRA account.
By doing so, you ensure that you have a wealth of tax-free money to draw from in retirement. Remember though the money must be in your account for 5 years before you can withdraw it.
Further, a Back-Door Roth should be done after you reach retirement age to avoid the early withdrawal penalties.
3. Tap Into Your IRA or 401k Early
By taking distributions from your IRA or 401k before you start getting Social Security benefits you can reduce the amount of taxes you'll pay later.
You can start taking distributions from your retirement accounts when you turn 59 and a half. If you do so, not only can you delay when you "officially" retire in Social Security's eyes but you can also ensure you'll get the delayed retirement credit if you don't retire until after 67.
Furthermore, by taking these distributions earlier when you have to start taking the required minimum distributions at age 72, they will be less. So, the taxes you'll on your benefits will be lower as well.
4. Reduce Your Income with Annuities
Annuities are contracts you buy to insure that you have a specific amount of income coming in every month. So if you buy a contract, and set it for a later date say, when you are 85, you will only start receiving that extra income when you turn 85.
More specifically, you would use the money from your 401k or IRA and buy a Qualified Longevity Annuity Contract (QLAC). This would effectively reduce the amount of your required distributions and allow you to control when you'll receive that extra income.
This may help you save or delay paying taxes on your Social Security benefits.
*Note: Some states tax Social Security benefits as well! These states include: Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Utah, Vermont, and West Virginia.
What is Supplemental Security Income? Is it different from Social Security?
Supplemental Security Income (SSI) is not the same as Social Security. SSI is for aged (over 65), blind, or disabled individuals (including children) who have limited income and resources and so need the extra money.
It is a needs-based program that is overseen by the Social Security Administration. A huge difference between SSI and Social Security is that SSI is not taxable.
You can receive both Social Security and SSI. But eligibility is restricted US citizens, nationals, and some refugee groups who reside in the one of the 50 states, Washington, D.C., or the Northern Mariana Islands.
US territories such as Guam, the Virgin Islands, Puerto Rico, and American Samoa are not eligible to receive SSI.
Currently, the benefit goes up to $794 for an individual and $1,191 for a couple, every month. There is also a benefit given to "essential persons" with a maximum benefit of $397 a month.
Here are the requirements to be considered an 'essential person'.
Supplemental Security Income is NOT taxable!
All in All
Knowing what you can expect in the future is always useful when planning. That is especially so when you are planning for your retirement.
Social Security and all its rules & regulations can seem like a ball of confusion but hopefully this post could help bring clarity to what you can expect for your Social Security benefits.
Retirement should be something you look forward to not something you stress about.
Happy Planning!
Want to know more? Check out the SSA site for more information.
*DISCLAIMER: The Information provided in this post is simply the opinions of the blogger and is given in the spirit of educational fun. It is not investment advice. Please do your own research and decide what is right for you before investing in any asset. If necessary, seek the help of a certified professional in discussing your options.