According to the 27th Annual Retirement Confidence Survey, three in 10 workers report that preparing for retirement causes them to feel mentally or emotionally stressed and less financially secure. Furthermore, just 18 percent of workers surveyed feel very confident about having enough money for a comfortable retirement.[1] Nearly 88 percent of those surveyed reported that Social Security provides a major or minor source of income for them and their spouses.
More than 43 million retirees and their spouses receive monthly social security retirement benefits.[2] These benefits keep tens of millions of American seniors above the poverty line, allowing them to support themselves instead of relying on charity.
Social Security retirement benefits serve the same function as pension payments.[3] Nearly half of American households have no retirement “nest egg” to speak of other than social security retirement benefits. There are several explanations for this, but often inaccurate assumptions that social security retirement benefits will be sufficient to cover retirees’ expenses may be the primary culprit.[4] In fact, the average American senior will not be able to enjoy his sunset years on social security alone. Currently, the average Social Security monthly benefit is just over $1,400, which amounts to less than $17,000 of annual income. Still, social security makes up an important component of retirement support for most Americans.
In this module, we will explain how a person becomes eligible for Social Security benefits, what she should consider in deciding when to retire and how Social Security retirement benefits are calculated.
Eligibility
To become eligible for Social Security benefits, a worker must have worked in “covered employment” for a specified number of calendar quarters, also called “quarters of coverage.”[5] The first calendar quarter begins January 1 and ends March 31; the second calendar quarter begins April 1 and ends June 30; the third calendar quarter begins July 1 and ends September 30; and the fourth calendar quarter begins October 1 and ends December 31.[6] The required number of quarters varies with the worker’s age. To receive retirement income, a worker born after 1929 must have at least 40 quarters of coverage credited to her work history, the equivalent of ten years of work.[7] If a worker can’t show that he’s worked at least 40 “quarters of coverage,” he is not entitled to benefits.
During a “quarter of coverage,” a worker must have earned the required minimum, which is adjusted annually for inflation.[8] For 2018, the amount of earnings required for a quarter of coverage is $1,320.[9] The figure refers to cash wages and does not include fringe benefits such as moving expense reimbursements, tuition assistance or commuting benefits.
More than nine out of ten workers in the United States are in employment or self-employment covered by Social Security.[10] The excluded workers fall into five categories:
– civilian federal workers who were hired before January 1, 1984;
– railroad workers who are covered under the railroad retirement system;
– certain state and local governmental employees who are covered by a state or local pension plan;
– domestic and farm workers whose earnings are below a minimum amount; and
– people with very low net earnings from self-employment.[11]
If a worker has any questions regarding his Social Security eligibility, he can request a “Personal Earnings and Benefit Estimate Statement” from the Social Security Administration.[12] To check an earnings history, the Social Security Administration urges Americans to create a “my Social Security” account, where one can find one’s personal information and can check to ensure its accuracy. If there are mistakes, one can contact the Social Security Administration to have the situation fixed.[13] Additionally, the Administration prepares and sends the statement annually to every person 25 years old and older during the third month preceding that worker’s birthday, free of charge. The report also includes the earnings reported in each year.[14]
Calculating Retirement Benefits
The Social Security Administration calculates a retiree’s Social Security benefit payments based on how much he earned during his working career, so higher lifetime earnings result in higher benefits during retirement. The calculation starts by calculating the “average indexed monthly earnings”, which can be done using a five-step process:
- Make a year-by-year list of earnings, excluding any earnings for each year that were more than the maximum amount subject to Social Security tax;
- Adjust earnings from prior years to present day (inflation adjusted) dollars;
- Select the 35 highest-earning years;
- Add up the total amount of earnings in those 35 years, and
- Divide this total amount by 420, which is the number of months in 35 years.
(If the person worked fewer than 35 years, steps 3-5 can be consolidated by taking the average, inflation adjusted, earning amounts in the years in which he worked. Essentially, if a person works more than 35 years, he gets the benefit of using only the top earning 35 years in the calculation.)[15]
The average indexed monthly earnings is then converted into a “primary insurance amount” by, as of 2018:
(a) taking 90 percent of the first $895 of the average indexed monthly earnings, and then adding
(b) 32 percent of the average indexed monthly earnings over $895 through $5,397, and then adding
(c) 15 percent of the average indexed monthly earnings over $5,397.[16]
This primary insurance amount is the benefit amount, assuming the person retires at the “full retirement age.” For most beneficiaries going forward, this will be 67. If a person chooses to start receiving benefits earlier or later than the full retirement age, the benefits will be lower (if retiring earlier) or higher (if retiring later). This segues to our next section.
Choosing When to Retire
No work-related decision may be as important, exciting and personal as deciding when to retire. The choice of when to retire also means higher or lower benefit payments under social security. Most financial advisers estimate that a retiree will need about 70 percent of pre-retirement income to live comfortably in retirement, which includes Social Security retirement benefits, investments and personal savings.
A person born between 1943 and 1954 can retire with full Social Security retirement benefits starting at age 66. For those born between 1954 and 1960, for each year after 1954, he must add two months to age 66 to determine his full retirement age.[17] For people born after 1960, the full retirement age is 67.
A retiree can start claiming Social Security retirement benefits as early as age 62. In fact, 62 is the single most popular age to start claiming benefits, with almost half of people claiming benefits at that age.[18] A retiree looking to claim his Social Security benefits doesn’t have to do so when he turns 62, however, and claiming benefits when under full retirement age causes a reduction in benefits.
Let’s look at an example:
Robert is a bank teller who retires from his job when he turns 62. He’s entitled to an annual Social Security benefit of $12,000 if he claims them as soon as he turns 62, but if he waits until age 67, he’ll receive an annual benefit of close to $18,000. This is because the benefits are based on the estimated benefits, adjusted for inflation, that Robert is expected to receive of the rest of his lifetime. Postponing benefits may also result in an increased benefit for his survivors. If he starts claiming benefits at age 62 and then lives until 87, he would receive $300,000 in lifetime benefits, but if he waited five years, claimed the benefits at age 67 and lives until age 87, he would receive about $360,000 in lifetime benefits.
If Robert decides that he doesn’t want to take retirement benefits at age 62 but wants to start claiming them 10 months before reaching full retirement age, his benefits will again be reduced, but the reduction won’t be as drastic. This time, his benefit will be reduced by a total of 5.56 percent based on the reduction formula. Instead of $18,000 per year, his benefits will be about $17,000 per year, far more than the $12,000 per year he’d get if he claimed benefits at age 62.
Under current laws, a retiree can also wait past full retirement age and until he turns 70 to begin receiving benefits. This way, he can collect more money per month because there is an increase of two-thirds of 1 percent for each month the retiree waits beyond full retirement age to collect benefits, leading to increase of about 8% each year.[19]
Working While Receiving Social Security Retirement Benefits
A person can collect social security retirement benefits while continuing to work. In fact, in a poll conducted by the Employee Benefit Research Institute in early 2017, nearly 79% of current workers stated that they planned to continue working in some capacity even after retiring.[20] In April 2000, President Bill Clinton signed into law The Senior Citizens Freedom to Work Act, which allows people over the age of 65 to receive Social Security retirement benefits and continue to work.[21]
A worker may begin full benefits at her full retirement age and no earning limits apply. So, after she reaches full retirement age, she can enjoy both full Social Security benefits and income from a job. However, if a worker is younger than full retirement age continues to work and earn more than a threshold amount ($17,040 as of 2018), retirement benefits will be reduced. The benefit reduction amount isn’t “lost” forever, though, as retirement benefits will increase at full retirement age to account for any benefits withheld due to earlier earnings.[22]
For example, assume Vince is a 64-year-old retiree and is receiving $1,000 per month in Social Security retirement benefits while working part-time earning $22,040 per year, which is $5,000 over the annual income limit. Since Vince is earning more than the annual limit, his benefits will be decreased by $1 for every $2 over the limit, which amounts to $2,500 per year. So, instead of receiving $12,000 per year in benefits, he’ll receive $9,500 instead. Once Vince reaches the full retirement age of 67, his benefits will no longer be affected, and his benefit amount will be recalculated to adjust for the income he earned.[23]
Self-Employment and Social Security
The typical person who pays into Social Security works for an employer who deducts Social Security taxes from the employee’s paycheck, matches that contribution, sends taxes to the Internal Revenue Service and reports wages to Social Security. The process is different if a person is self-employed because he’s both the employee and the employer.
If someone is self-employed, he must report his earnings and pay taxes directly to the IRS in the form of the self-employment tax. In 2018, the rate is 15.3 percent, with 12.4 percent allocated to Social Security and 2.9 percent for Medicare.[24] A self-employed person must pay a self-employment tax if she had net earnings of $400 or more. The maximum amount of self-employment income subject to a Social Security tax is $128,700, as of 2018. A self-employed worker must fill out a Schedule SE on his Form 1040 to report and pay this tax.
The employer’s half of the social security tax paid by a self-employed person may be taken as an “above-the-line” income tax deduction, which reduces the taxpayer’s “adjusted gross income.”
Like an employee, the self-employed worker earns work credits towards eligibility for social security benefits in much the same way. To be eligible, he must earn 40 work credits, which usually amounts to 10 years of work.
[1] Lisa Greenwald, et. al., The 2017 Retirement Confidence Survey: Many Workers Lack Retirement Confidence and Feel Stressed About Retirement Preparations, Employee Benefit Research Institute, (Mar. 21, 2017), https://www.ebri.org/pdf/surveys/rcs/2017/IB.431.Mar17.RCS17..21Mar17.pdf.
[2] Table 1. Number of People Receiving Social Security, Supplemental Security Income (SSI), or both, January 2016 (in thousands), Social Security Administration, https://www.ssa.gov/policy/docs/quickfacts/stat_snapshot/2016-01.pdf (last visited June 29, 2018).
[3] Industrial Claim Appeals Office v. Romero, 912 P.2d 62, 66 (Colo. 1996).
[4] Maurie Backman, 3 Social Security Misunderstandings That Could Cost You, USA Today, (Apr. 12, 2018), https://www.usatoday.com/story/money/personalfinance/retirement/2018/04/12/3-social-security-misunderstandings-that-could-cost-you/33653013/.
[5] SM054 ALI-ABA 1: Basic Benefits-Social Security, Medicaid and Medicare
[6] 547 Quarters of Coverage, United States Postal Services, https://about.usps.com/manuals/elm/html/elmc5_053.htm (last visited June 29, 2018).
[7] 42 U.S.C. § 414(a)(2).
[8] 42 U.S.C. § 413(a)(2)(A).
[9] Quarter of Coverage, Social Security Administration, https://www.ssa.gov/oact/cola/QC.html (last visited June 29, 2018).
[10] Introduction to Social Security, Social Security Administration, https://www.ssa.gov/section218training/basic_course_3.htm#7 (last visited June 29, 2018).
[11] Kathryn Moore, Employee Benefits Law Symposium: The Future of Social Security:Principles to Guide Reform, 41 J. Marshall L. Rev. 1061, 1065 n. 27 (2008).
[12] RM 01305.001 The Social Security Statement, Social Security Administration, https://secure.ssa.gov/poms.nsf/lnx/0101305001 (last visited June 29, 2018).
[13] Dan Caplinger, Social Security Wants You to Do These 5 Things to Plan for Retirement, Motley Fool (Apr. 7, 2018), https://www.fool.com/retirement/2018/04/07/social-security-wants-you-to-do-these-5-things-to.aspx.
[14] RM 01305.001 The Social Security Statement, supra note 12.
[15] Social Security Benefit Amounts, Social Security Administration, https://www.ssa.gov/oact/cola/Benefits.html(last visited June 29, 2018).
[16] Primary Insurance Amount, Social Security Administration, https://www.ssa.gov/oact/cola/piaformula.html (last visited June 29, 2018).
[17] Peter Dunn, Pete The Planner: Health is a Factor When Doing the Math on Social Security Enrollment, USA Today, (Apr. 13, 2018), https://www.usatoday.com/story/money/personalfinance/columnist/2018/04/13/pete-planner-health-factor-when-doing-math-social-security-enrollment/474799002/.
[18] Katie Brockman, 96% of Americans Are Not Taking Advantage of This Social Security Benefit, Motley Fool, (Apr. 17, 2018), https://www.fool.com/retirement/2018/04/17/96-of-americans-are-not-taking-advantage-of-this-s.aspx.
[19] Carrie Schwab-Pomerantz, Social Security: Should You Want Until Age 70 to Collect?, Charles Schwab,https://www.schwab.com/resource-center/insights/content/social-security-should-you-wait-until-age-70-to-collect.
[20] Lisa Greenwald, et. al., The 2017 Retirement Confidence Survey: Many Workers Lack Retirement Confidence and Feel Stressed About Retirement Preparations, Employee Benefit Research Institute, (Mar. 21, 2017), https://www.ebri.org/pdf/surveys/rcs/2017/IB.431.Mar17.RCS17..21Mar17.pdf.
[21] 42 U.S.C.S. § 402; Social Security Legislative Bulletin, Social Security Administration, (Apr. 7, 2000), https://www.ssa.gov/legislation/legis_bulletin_040700.html.
[22] How Work Affects Your Benefits at 6, Social Security Administration, https://www.ssa.gov/pubs/EN-05-10069.pdf (last visited June 29, 2018).
[23] Bethany K. Laurence, Will I Get Penalized for Working While Collecting Social Security Retirement?, NOLO https://www.nolo.com/legal-encyclopedia/will-i-get-penalized-working-while-collecting-social-security-retirement.html (last visited June 29, 2018).
[24] I’m Self-Employed. Do I Still Have to Pay Social Security and Medicare Taxes?, AARP, https://www.aarp.org/work/social-security/question-and-answer/self-employed-do-i-still-have-to-pay-social-security-and-medicare-taxes.html (last visited June 29, 2018).