If you're like most Americans, you'll claim Social Security retirement benefits some day, if you haven't already. These are earned benefits, and maximizing the amount could be crucial to your financial security in retirement.
That's why it's so important for everyone to understand these four key rules that govern the Social Security program.
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1. What your full retirement age is, and how claiming before or after it affects benefits
One of the most important rules to be aware of is the regulation dictating when you get your standard retirement benefit.
The Social Security Administration sets a full retirement age (FRA) for everyone. It used to be 65, but now it depends on your birth year and is between 66 and 2 months and 67. And when you file relative to your FRA is instrumental in determining the size of your monthly retirement payout.
- If you file right at FRA, you receive your standard benefit.
- If you file ahead of FRA (you become eligible at age 62), benefits are reduced by 5/9 of 1% per month for the first 36 months. This results in a 6.7% annual decrease for each of the first three years.
- If you file more than 36 months ahead of FRA, benefits are reduced by 5/12 of 1% per month for each additional month. This results in an additional 5% benefit decrease per year.
- If you file after FRA, you get a benefit increase equaling 2/3 of 1% per month up until age 70. This amounts to an annual 8% benefit increase.
Retiring before FRA could result in as much as a 30% benefit reduction if you start checks at 62 when your FRA is 67. By contrast, waiting from age 67 to 70 could raise your checks by 24%. It's easy to see why knowing this rule is so essential, so check out the table below to see what your FRA is.
| If You Were Born in: | Your Full Retirement Age Is: |
|---|---|
| 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 or later | 67 |
Table by author. Data source: Social Security Administration.
2. The Social Security formula that determines your benefit
Speaking of your standard benefit, you also need to know how it's determined. It's based on a percentage of average wages during your 35 highest earning years. This average is called your Average Indexed Monthly Earnings, or AIME. Specifically, your benefit equals:
- 90% of AIME up to a first bend point
- 32% of AIME between a first and second bend point
- 15% of AIME above the second bend point
The bend points are income thresholds, and the ones that matter to you are those in effect when you turn 62. In 2021, the first bend point is $996 and the second is $6,002. Your bend points differ if you turn 62 in a different year.
Knowing this formula is important mostly because you need to know that working less than 35 years reduces your AIME and thus reduces your average benefit. And working longer than 35 years could raise your AIME if you're earning more later in life and can thus replace some lower-earning years with higher-earning ones in the AIME calculation.
3. When you're entitled to spousal or survivors benefits
Spousal and survivors benefits could potentially be worth more than your own retirement income if you didn't earn very much or didn't work enough to earn Social Security on your own. But you must know when you're entitled to them.
Obviously, if you're married when you retire or when your spouse dies, survivors or spousal benefits are an option for you. But you can also get these benefits if you divorced after a marriage lasting at least 10 years and you either haven't remarried (in the case of spousal benefits) or didn't remarry prior to age 60 (in the case of survivors benefits).
4. What tax rules govern Social Security
Finally, you need to know what taxes (if any) will be taken out of your benefits. On the federal level:
- Up to 50% of your benefits are subject to tax if your provisional income is $25,000 to $34,000 as a single filer or $32,000 to $44,000 as a married joint filer.
- Up to 85% of your benefits are subject to tax if your provisional income exceeds $34,000 as a single filer or $44,000 as a married joint filer.
Provisional income is all taxable income, plus half your Social Security benefit amount, plus some non-taxable income such as interest earned from municipal bonds. If you're concerned you'll be subject to these taxes, investing in a Roth IRA instead of a traditional one could help you avoid them since Roth distributions don't count as provisional income.
On the state level, you won't need to worry about taxes on benefits regardless of income if you live in one of the 37 states that don't tax Social Security. In the remaining 13, you'll need to know your state's rules to see if you'll lose some of your retirement benefits to local taxes.
By understanding all of these rules, you can make an informed choice about maximizing your benefits and will have a better idea of how much you'll get to keep after taxes. This can help you be much better prepared for retirement.
