As people grow older, there’s a certain point in their life where they must stop working and earning money. This is when social security takes on a very important role as it becomes the financial resource for retired people.
What Is Social Security?
In United States, social security is the federal Old-Age, Survivors, and Disability Insurance (OASDI) program. This social insurance program is funded by payroll taxes from the Federal Insurance Contributions Act (FICA). The U.S. government spends the most amount of money on the social security program, which makes it the largest government program in the world.
How Your Social Security Benefits Are Calculated
Your social security benefit is calculated based on your average income/earnings over the entire working period. The calculations ARE NOT based on the last five years or the highest three years. Below is a simple step-to-step guide that summarizes how your social security benefit is determined at the age of 62. To know how you can maximize your benefit, please read Tips on Maximizing Social Security Benefit.
Step 1 – Your total number of working years is determined as a base. If you were born after 1928, your base would be the highest 35 years of income. However, if you were born before or in 1928, the number of years in your base would be less than 35.
Step 2 – Your earnings are adjusted for wage inflation.
Step 3 – Your average monthly income is adjusted based on the number of years determined in Step 1 ($0 income would be used if you do not have 35 years of earnings).
Step 4 – Your average adjusted monthly income is multiplied by percentages in a certain formula (given by law). The formula gives you the benefits in place of a percentage of your income. The formula is generally geared towards the low-income workers, who don’t have many savings and/or investments during their working period. Therefore, the percentage is higher for people in the lower income brackets, and lower for people in the higher income brackets.
Interesting Facts
Social security does not automatically start on its own when you retire. You must apply for it by making an appointment with your local social security office, or call 1-800-772-1213.
You must fill out a Form 7004 Request to obtain social security statements related to your total earnings recorded in your account, estimation of your present disability and death benefits, and prediction of future retirement benefits. This form can be obtained from your local social security office.
You should check your social security record every three years. If there’s a mistake and you fail to recognize or correct it within three years, that mistake would become permanent.
If you begin to obtain social security benefit and earn above the annual earnings limit (the annual earnings limit in 2010 is $14,160) at 62 years old, your social security benefit would be decreased. The total benefits between age 62 and your full retirement age would decrease by $1 for every $2 you earn over the limit. During the year and the month before you reach the full retirement age, social security would decrease by $1 for every $3 you earn over the limit. So, your social security benefit would be lowered if you take any before your full retirement age. Read When Should You Collect Social Secirity Benefits for further details.
Note:Investment income is not included in the annual earnings limit. Nonetheless, the amount of benefits you lose by working is re-paid back to you when you are at the full retirement age. The repayment is in the form of higher monthly payments. If you continue to work after the full retirement age, the total benefits would not be reduced, but they could be taxable if your income is extremely high.
The full retirement age has increased for people born after 1937. People born before 1937 have the full retirement age of 65. People born from 1938 to 1959 have the retirement age between 65 and 67. People born in 1960 and after have the full retirement age of 67. For the exact number of your full retirement age, please see the table below (source: www.socialsecurity.gov):
Note:Your full retirement age may be different if you are eligible to be a survivor.
Year of Birth
Full Retirement Age
1937 or earlier
65
1938
65 and 2 months
1939
65 and 4 months
1940
65 and 6 months
1941
65 and 8 months
1942
65 and 10 months
1943 - 1954
66
1955
66 and 2 months
1956
66 and 4 months
1957
66 and 6 months
1958
66 and 8 months
1959
66 and 10 months
1960 and later
67
*If you were born on January 1st of any year you should refer to the previous year.
The disability benefits from your social security stops when you reach the full retirement age. The month before you reach the full retirement age, your disability benefits would automatically transfer to your retirement benefits.
You have a maximum limit on your family benefit. This is usually 150% to 180% of your working benefit. Your family benefit would be lowered if the maximum limit is exceeded.
There are two social security trust funds. One is to finance retirement and survivor benefits. The other is to finance the disability program. Money that are not used for current benefits are invested in the U.S. Government Treasury bonds (this is required by law).
If you have other sources of income, excluding social security, you would have to pay taxes on your social security benefits. Other sources of income include wages, self employment income, interest and dividends, or pension income. Read Taxes on Social Security Benefits for details.
Ex-spouses, widows and divorced widows can qualify for their spouse’s account’s benefits, under the circumstances that all requirements are satisfied. More on this topic can be found on The Social Security Spousal Benefits.
Social security is an extremely important resource for all retired individuals. It is highly suggested that you meet with your financial planner to learn about all the benefits available to you in advance.
In United States, social security is the federal Old-Age, Survivors, and Disability Insurance (OASDI) program. This social insurance program is funded by payroll taxes from the Federal Insurance Contributions Act (FICA). The U.S. government spends the most amount of money on the social security program, which makes it the largest government program in the world. 