Social Security is America’s national pension fund. In its current state, Social Security is underfunded by roughly 30%. Meaning, whatever Social Security payment that is promised to you once you retire, you will get 30% less if nothing changes.
Given the weakness of Social Security, I encourage readers to adopt the new three-legged stool for retirement, which states that in order to retire comfortably, you need to depend on:
- You for saving in your 401(k), 403(b), and IRAs
- You for building up a taxable retirement portfolio
- You for taking on extra work on the side or during retirement
Social Security will most likely be there for you when you retire. However, I encourage all Financial Samurai readers to never depend on the government for anything.
Let’s go over the basics of Social Security and some Social Security tips I have for a better retirement.
What Is Social Security?
Social Security is a federal government run program that consists of a number of components, including Old Age insurance (OAI), disability insurance (DI), Medicare, and Medicaid.
Social Security taxes are deducted through your employer’s payroll, as required by the Federal Insurance Contributions Act (FICA). This is what funds Social Security and Medicare trusts.
For 2020, the income limit for maximum Social Security tax is $137,700.
Raising the income limit for Social Security tax from $132,900 in 2019 to $137,700 in 2020 brings in more funds, thereby increasing the viability of our national pension system.
It is estimated that Social Security’s long-term unfunded liability is now $43 trillion, up from $34 trillion last year. The fiscal gap equates to an estimated 33 percent underfunding.
For those of you who believe you can manage your money better than the government, the bad news about raising the income limit for Social Security tax is that we might be throwing good money after bad. Raising the income limit by $4,800 or 3.5% should be concerning.
Social Security Tax Level
Social Security tax is a payroll tax that is automatically withheld on your wage and tax statement each pay cycle. Below is a typical Wage and Tax Statement that shows Social Security tax withheld in box 4 and Medicare tax withheld in box 6.
The Social Security tax rate is 12.4% – 6.2% withheld from the employer and 6.2% withheld from the employee.
The Medicare tax rate is 2.9% – 1.45% withheld from the employer and 1.45% withheld from the employee.
The total Social Security + Medicare (FICA) tax rate is 15.3%. If you are self-employed, you must pay the full 15.3%, but you can take a deduction for half this amount.
Unfortunately or fortunately, there is no maximum on Medicare tax, but there is an additional Medicare tax of 0.9% for high-income taxpayers with earned income of more than $200,000 ($250,000 for married couples filing jointly)
Maximum Social Security Benefits
The maximum Social Security benefit for someone retiring at full retirement age in 2019 is $2,861 and will go up 1.6% or so in 2020.
The average Social Security benefit is closer to $1,450 a month. Receiving the average $17,400 a year in Social Security benefits is good supplemental income. But it’s not enough to live a comfortable retirement lifestyle in most parts of the country.
- All Retired Workers: $1,461/month
- Aged Couple, Both Receiving Benefits: $2,448/month
- Widowed Mother, and 2 Children: $2,876/month
- Aged Widow(er) Alone: $1,386/month
- Disabled Worker, Spouse, & One or More Children: $2,130/month
- All Disabled Workers: $1,234/month
To get some perspective, here are the maximum wages subject to Social Security since 2000.
Based on the income limit increase trend, I expect the average increase per year to be around 3%, forever. By 2030, the income limit for Social Security tax will be $185,000 if we assume a 3% compound increase.
Social Security Is Important For Most Americans
Most Americans don’t read personal finance sites like Financial Samurai. As a result, most Americans are not focused on optimizing their finances by saving more and making more money through side hustles and investing. If you look at the data, most Americans have an underwhelming amount of retirement funds.
As a result, Social Security is important for most Americans and their retirement plans.
Pensions are fading away. Less than 25% of Americans have pensions. For those who do have pensions, they have truly won the lottery because pensions are very valuable if they pay out until death.
Public sector pensions, which had been thought to be untouchable, have increasingly been open to attack, particularly in the follow-up to the Great Recession, when austerity ripped through city budget decision-making.
Just look at Congressional salaries, they haven’t increased since the mid-2000s. Finally, the government is getting their act together.
Meanwhile, only 60% of the population has access to a 401K or other defined contribution plan. And only ~42% of the population participates in one. 401(k) and IRA plans clearly cannot replicate the value of a pension.
That said, we must all do our best to max out our 401(k) plans every year if we want a healthy retirement. Below is the latest median and average 401(k) balance by age versus the recommended amount for all Financial Samurai readers.
Again, since most Americans don’t care enough about their finances to reader a website like Financial Samurai, most Americans just wing it. The problem with winging your finances is that you might wake up 10, 20, 30 years from now and wonder where all your money went!
The main source of income for retirement for 50% of married couples and 71% of unmarried persons is Social Security. And you know what? Those who can receive Social Security today are really benefiting. Receiving the average Social Security benefit of roughly $1,450 goes a long way in retirement, if the retiree has no debt.
Social Security Will Survive
Although Social Security has roughly a 30% underfunding hole, it is fully funded by 2034 if nothing changes. In other words, those eligible to get Social Security today are good until 2034 before cuts or other changes are made.
In order to fully fund Social Security for decades and decades to come, one or more of the following need to happen:
- Population growth will have to accelerate. This is unlikely to happen due to rising costs, rising desire to make more money and have longer careers, and the equality of women in the workplace.
- Raise the qualifying age to receive Social Security benefits
- Decrease payment benefits
- Raise the income limit to tax Social Security while reducing the maximum benefits
- Increase the Social Security tax rate
- Reduce the cost of living increase for benefits each year (probably the easiest solution)
Due to politics and the desire for politicians to stay in office, it is unlikely that any one of these things will happen. The can will continue to be kicked down the road. As a result, every American should not wait for the government to save them, and take action to save and invest aggressively.
Don’t Use Social Security As A Retirement Crutch
Yes, most Americans support Social Security because most Americans haven’t saved enough in their retirement accounts to properly fund their retirements.
In a 2014 survey of Americans on Social Security, 95% of respondents said receiving Social Security was important for their retirement planning. At the same time, 86% believe Social Security benefits do not provide enough for retirees. Meanwhile, 77% agree it is critical to support Social Security benefits for future generations.
But if you are one of the Americans who are 100% dependent on Social Security to live a comfortable retirement, I’m pretty sure you are going to be 100% disappointed. Do not us Social Security as a retirement crutch!
Income Subject To Social Security Tax
You do not have to pay Social Security taxes on unearned income such as capital gains, dividends, and interest.
Social Security taxes are only required for earned income, i.e. wages, bonuses, or self-employed net income.
Given this difference, it’s all the more important to generate retirement investment income. Long-term capital gains tax rates are lower. You can actually earn up to $38,600 as an individual and pay no long-term capital gains tax.
How Are Social Security Benefits Calculated?
Social Security benefits are calculated based off of your Social Security taxable earnings, how many years you have worked, and the age that you start claiming benefits.
Social Security payments are based off of your top 35 years of taxable income. If you have 50 years of income, it’s based off the top 35. If you have 25 years of income, for example, the other 10 years will count as $0.
You have to have a minimum of 10 years of taxable income in order to receive any individually earned benefits, but there are income thresholds that you must pass in those years. You can earn a maximum of 4 “credits” per year and need 40 credits total in order to be eligible to receive Social Security benefits.
Therefore, for those of you who want to retire early and live the good life, know that your Social Security benefits will be curtailed once you are eligible to collect. That said, presumably the reason why you were able to retire early is because you built a large enough taxable retirement portfolio to live off the income.
Below is a sample of how much you should accumulate in your after-tax accounts by age if you want to retire early.
What Is The Best Age To Claim Social Security?
The best age to claim Social Security is when you need the money to survive and are eligible.
As of now, you are eligible to begin claiming Social Security as early as age 62. The normal retirement age is currently age 67, for those born in 1960 and later. You can delay claiming up until age 70 if you have enough money, feel like you will live a long time, and would like a higher benefit amount per year.
If you claim prior to age 67, your benefit payments may decline by up to 30% per year for the rest of your life. Benefits are reduced 5/9ths of 1% for each month before normal retirement age, up to 36 months. If the number of months exceeds 36, then the benefit is further reduced 5/12ths of 1% per month.
If you claim after the full retirement age of 67, benefits increase, and continue to do so up to age 70. Each year you delay adds an additional 8% to your payments (up to a 24% maximum credit for delaying).
In my opinion, you’ve got to be really desperate and/or really unhealthy to want to claim Social Security at age 62. Although the median life expectancy is roughly 80, it sure feels like those we stay fit are living longer and healthier lives.
But only you know your financial situation and health.
Social Security Spousal Benefits
If you die without a spouse and have no dependents under 18, your Social Security benefits go to nobody. This fact is why some people really dislike Social Security. Imagine paying all that FICA tax for so many years, dying alone, and having none of the benefits go to anybody. Sad!
Therefore, everyone should figure out a way to get married before they die so that your Social Security benefits go to someone, in case of your untimely death.
Spouses are entitled to receive the greater of his/her own benefit or half of their spouse’s benefit. And surviving widows can step up to 100% of a deceased spouse’s benefit.
Here is information from the IRS regarding survivor benefits.
Who Receives Benefits?
Certain family members may be eligible to receive monthly benefits, including:
- A widow or widower age 60 or older (age 50 or older if disabled);
- A surviving divorced spouse, under certain circumstances;
- A widow or widower at any age who is caring for the deceased’s child who is under age 16 or disabled and receiving benefits on their record;
- An unmarried child of the deceased who is:
- Younger than age 18 (or up to age 19 if he or she is a full-time student in an elementary or secondary school); or
- Age 18 or older with a disability that began before age 22.
Other Family Members
Under certain circumstances, the following family members may be eligible:
- A stepchild, grandchild, step grandchild, or adopted child; and
- Parents, age 62 or older, who were dependent on the deceased for at least half of their support.
Check Out Your Social Security Benefits Online
If you’re curious about how much Social Security you’re expected to get, you can check out ssa.gov and input your information. You can also call 1-800-772-1213 between 7 am – 7 pm Monday through Friday EST.
If you forget your password, it might take you ages to get one back because they will mail you your information, and that mail sometimes gets lost.
SSA currently only mails statements to workers age 60 and over who aren’t receiving Social Security benefits and do not yet have a “My Social Security account”.
Social Security Is Better Than A Poke In The Eye
Although Social Security is underfunded and doesn’t pay out that much ($1,450/month on average), it’s still better than nothing.
Pretend like you have no other income and you’re retired right now. Can you survive off $1,450/month? If so, you’re good to go! If not, it’s best to start aggressively building your retirement portfolio by maxing out your 401(k) and saving at least 20% of your after-tax income.
As an early retiree, I do not count on Social Security. If it happens to be there for me in my 60s, fantastic. If not, I don’t care because I’m not trusting my finances in the hands of the government and neither should you.
Currently, I’m actively investing in dividend stocks and real estate crowdfunding to build my retirement income. I believe stocks and real estate are winners over the long term. Bonds have been a steady rock as well.
Tip For Managing Your Retirement
Sign up for Personal Capital, the web’s #1 free wealth management tool to get a better handle on your finances. In addition to better money oversight, run your investments through their award-winning Investment Checkup tool to see exactly how much you are paying in fees. I was paying $1,700 a year in fees I had no idea I was paying.
After you link all your accounts, use their Retirement Planning calculator that pulls your real data to give you as pure an estimation of your financial future as possible using Monte Carlo simulation algorithms. Definitely run your numbers to see how you’re doing. I’ve been using Personal Capital since 2012 and have seen my net worth skyrocket during this time thanks to better money management.