Understanding Social Security Retirement Benefits

Aaron Ammerman |

Deciding when to begin taking Social Security benefits is an important and multifaceted consideration that should be factored into each individual’s broader retirement plan. Popular wisdom suggests jumping at the opportunity to collect Social Security retirement benefits as soon as possible, which currently is age 62. While this strategy may have been prudent for millions of Americans in the past, longer life expectancies have changed the face of retirement planning. Waiting to collect Social Security benefits may well be a more advantageous option. There is no one-size-fits-all approach. In the following pages, we review key details to consider in your Social Security decision-making. We encourage you to consult with your financial and tax professionals to ensure your Social Security strategy complements your overall retirement plan.

Qualifying for Benefits

When you work and pay taxes as mandated by the Federal Insurance Contributions Act (FICA), you earn “credits” toward Social Security retirement benefits. The credits are based on your annual earnings, with a maximum accrual of four credits per year. Once you have acquired 40 credits (approximately 10 years of employment), you are fully insured and eligible to receive retirement benefits. FICA tax (often displayed on pay statements as OASDI, for old-age, survivors and disability insurance, tax) is withheld from each paycheck until you have earned up to the taxable earnings base for the year.

Collecting Benefits at Full Retirement Age

Your primary insurance amount (PIA) is the monthly benefit for which you are eligible at your full retirement age (FRA). FRA varies based on year of birth. Originally age 65, the federal government has increased FRA for anyone born after 1937 in recognition of longer life expectancies. To determine your PIA, the Social Security Administration (SSA) uses your best 35 years of employment to arrive at your Average Indexed Monthly Earnings (AIME). If you have not worked for 35 years, some of the included earnings may be zero. For more information, please visit www.ssa.gov. If you continue working after reaching FRA, the SSA will automatically recalculate your benefits each year you continue to work. If your current income is greater than any of your previously calculated “best 35 years,” your benefits will be adjusted upward. The increase generally will be made in October of the following year but will be retroactive to January 1.

Social Security retirement benefits are automatically modified each year for Cost-Of-Living Adjustments (COLAs), which are either positive or zero — never negative. COLAs are based on the Consumer Price Index and have averaged around 1.5% over the past 10 years.

Collecting Benefits Earlier

While your PIA is payable at your FRA, you are entitled to collect benefits as early as age 62. However, if you choose to collect early, you will permanently reduce the size of your benefits. Your benefits will not be adjusted upward when you attain FRA. The amount of your reduction will depend on two factors — your FRA and the number of months before it that you start collecting. If you begin taking benefits on your 62nd birthday, you are subject to the maximum reduction. That reduction will be smaller for each month you delay benefits after age 62 but prior to reaching FRA.

Working While Collecting Benefits Prior to FRA

Since Social Security benefits are intended to be supplemental retirement income, there are consequences to collecting your benefits early if you are not retired and are still receiving wages. If you opt to collect benefits prior to FRA, you are subject to an earnings test every year until you reach FRA. If your earnings exceed certain thresholds, the SSA will withhold part or all of your benefits. The earnings test for individual and survivor benefits looks only at the salary or wages of the individual collecting early benefits. It does not consider any other type of income, nor does it consider the salary or wages of a spouse. However, the test on spousal benefits (see page 6) may take into account both spouses’ wages if both are under FRA.

Withheld Benefits

Benefits withheld by the SSA due to early collection will not be refunded. However, your benefits will be adjusted at FRA to account for the benefits that were withheld. For example, if your FRA was 66 and you began collecting benefits at age 62, the SSA would have reduced your benefit by 25%. Assuming you returned to work at age 64, the SSA may have withheld two years’ worth of benefits by the time you reached FRA. The SSA would then lessen your 25% reduction to give you credit for the two years of lost benefits. Your new reduction would be as if you started collecting benefits at age 64 (13.3% reduction) rather than age 62.

Waiting to Collect Benefits

If you elect to defer collecting benefits beyond your FRA, the SSA will give you a Delayed Retirement Credit (DRC) for every month you defer between FRA and age 70, the age at which your benefits max out. This increase will be in addition to the annual COLA, if applicable. Depending on your year of birth, your increase will amount to 7% to 8% annually.

Changing Your Mind

If you start collecting Social Security benefits and change your mind you can file a “Request for Withdrawal of Application” form with the SSA. Assuming your withdrawal request is granted, you must repay the SSA all of the payments you and anyone else collected based on your work history. There is no penalty or interest on the amount repaid and you may subsequently refile for your Social Security benefits. Importantly, withdrawal requests must occur within 12 months of commencing benefits and you are allowed only one withdrawal request in your lifetime. If any of the benefits repaid were subject to federal income tax (see next section), you may be entitled to an itemized deduction on your tax return in the year of repayment. We encourage you to consult with your tax professional to ensure your deduction is appropriately applied.

Taxation of Benefits

About one-third of people who collect Social Security benefits are required to pay income taxes on them. Individuals with high total incomes must include up to 85% of their benefits as income for federal income tax purposes. Special step-rate “thresholds” on provisional income determine the amount which you may be taxed. The thresholds for taxation of your benefits are not currently indexed for inflation.

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