Social Security: An Introduction

Social Security is a U.S. government program that was established in 1935. It's best known as a source of benefits for some 57 million retired Americans, dependents, and surviving spouses. Another 9 million Americans and their dependents receive benefits through Social Security's disability income insurance program.

The Social Security system is funded primarily through a payroll tax that's shared by employees and their employers. The Federal Insurance Contributions Act (FICA) mandates a 12.4% levy on employee earnings up to an earned income cap that's adjusted yearly. The cap is set at $160,200 for 2023. The employer and the employee split this down the middle, each paying 6.2%. Self-employed people pay both shares for a total of 12.4%.

Key Takeaways

  • Payroll taxes fund the Social Security system, with employers and employees paying 6.2% each on earned income up to an annual cap set at $160,200 in 2023.
  • Eligibility for Social Security is determined by quarters of coverage or credits, with one credit awarded up to a maximum of four a year for covered earnings set at $1,640 in 2023.
  • A worker must accrue a total of 40 credits or one credit for each year after turning 21 to receive Social Security benefits.
  • The benefits formula considers the average earnings, indexed for inflation, for the 35 years in which the worker earned the most employment income.
  • Those born between 1943 and 1954 can collect full benefits from age 66. The age of eligibility gradually increases to 67 for those born in 1960 or later.
  • Reduced Social Security benefits are available from age 62, but waiting to collect benefits at age 66 or 67 and up to age 70 increases the monthly payouts.

How Social Security Works

It would be reasonable to think that the money you pay in payroll taxes as an employee is set aside in a fund for you, awaiting your retirement. But that's not how it works. Payroll tax receipts, investment income, and other cash reserves are combined to pay monthly benefits to retirees who are currently receiving benefits.

The two Social Security trust funds (one for retirement benefits, the other for disability claims) invest their reserves in special issue U.S. government debt securities that are available only to the funds. The reserves have also been invested in publicly-traded U.S. Treasury bonds at times.

Is the Social Security Fund Running Dry?

The trust fund that's used to pay Social Security retiree benefits will be unable to pay its obligations in full as of 2033, according to a 2023 projection from the fund's trustees. The same report estimates that the trust fund that's used to pay for Medicare Part A coverage will be inadequate by 2031.

How Eligibility Is Determined

People accrue eligibility for Social Security benefits by paying into the system over time through the payroll tax deduction. To qualify for full benefits, they must accumulate what the government terms a "quarter" of coverage, also known as a credit, for each calendar year after they turn 21 and the earliest of the following:

  • The year before they turn 62
  • The year before they die
  • The year before they become disabled.

The quarter of coverage is a level of earnings that is subject to Social Security payroll taxes. This number is indexed for inflation and is set at $1,640 for 2023.

Workers can accumulate up to four quarters of coverage (or credits) in a year and need a minimum of six quarters of coverage over their careers to qualify for Social Security benefits, provided they have also earned a quarter of coverage for each year after the age of 21 and before benefit eligibility, as noted above.

The maximum number of quarters of coverage necessary to qualify is 40.

Be sure to sign up separately for Medicare by age 65 if you're planning to delay applying for Social Security benefits. Failing to do so may delay your Medicare coverage and increase its cost.

Calculating Benefits

The formula for calculating Social Security benefits uses your average earnings, indexed for inflation, from the 35 years in which you earned the most employment income that was subject to payroll taxes. The 2023 formula for the "primary insurance amount," or the monthly Social Security benefit, is the sum of three numbers:

  • 90% of the first $1,115 in average indexed monthly earnings from those highest-paid 35 years
  • 32% of average indexed monthly earnings between $1,115 and $6,712
  • 15% of average monthly earnings above $6,721

The dollar amounts of these benefit brackets, also known as "bend points," change annually because they're indexed for inflation. The percentages for each bracket remain the same from year to year.

Social Security As Income Replacement

The formula means that people with lower lifetime earnings receive a larger proportion of their earnings in Social Security benefits. Benefits started at full retirement age can replace as much as 75% of covered income for the lowest-paid workers but only about 27% for the highest earners, according to the SSA. The maximum Social Security benefit for a worker retiring at full retirement age is $3,627 per month in 2023.

Calculators on the Social Security website can help you figure out what your benefit will be. You can apply up to four months before you want to begin receiving benefits.

You may be eligible to receive retirement benefits based on your spouse's earning history even if you never contributed to Social Security. This is the case even if you're divorced as long as your marriage lasted at least 10 years, or if your spouse is deceased.

Social Security Eligibility

The age for receiving full Social Security benefits is 67 for everyone born in 1960 or later. You can begin collecting Social Security as early as age 62, but the amount you receive will be permanently reduced. You can get a bigger check by waiting to collect until age 70.

Following the extension of the full retirement age in 1983, workers qualify for full benefits according to the following schedule:

Year of Birth Full (normal) 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 to 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

Plan for Your Retirement

Social Security was never designed to serve as the sole source of a retiree's income. The SSA notes that "on average, Social Security will replace 40% of your annual pre-retirement income." You may need as much as 80% of your pre-retirement income to retire comfortably.

The best way to achieve a secure retirement is to take matters into your own hands. This means making sure to take advantage of a 401(k) or a similar tax-advantaged retirement plan if your employer offers one, as well as investing in a traditional or Roth IRA.

The Future of Social Security

There have been concerns for many years that the Social Security system is simply not financially sustainable, and they're not unfounded. The 2023 annual report from the trustees of the Social Security and Medicare trust funds finds that:

  • The Old-Age and Survivors Insurance Trust Fund will be able to pay its scheduled benefits in full only until 2033. That's one year earlier than was estimated in its report in 2022. This is the source of Social Security retirement checks.
  • The Hospital Insurance Trust Fund will be able to pay its scheduled benefits in full only until 2031. That's three years earlier than 2022's estimate. This is the source of Medicare Part A coverage.
  • The Disability Insurance Trust Fund will be able to pay its scheduled benefits through at least 2097, which is as far into the future as the report projects. This is the source of Social Security payments to the disabled.

How Much Per Month Will I Get for Social Security?

The amount you'll receive per month for Social Security depends on the age you start taking benefits, your earnings while you were paying into the system, and other factors. You can get a rough estimate of your benefit in the Social Security Administration's online benefits calculator.

The maximum benefit you can receive in 2023 is $4,555 if you start taking benefits at age 70. The average Social Security benefit in February 2023 was $1,693.88.

How Do I Find My Social Security Benefit Amount?

Your first stop should be the Social Security Administration's website. You can set up a personal account that allows you to review your current information and even apply for benefits when you're ready.

What Is the Maximum Social Security You Can Collect?

The maximum Social Security benefit that you can collect will depend on your retirement age. As of 2023, the maximum amount is $2,572 if you retire at age 62. The maximum amount is $3,808 if you retire at full retirement age. And if you retire at age 70, the maximum amount is $4,555. The numbers are revised annually for inflation.

The Bottom Line

Social Security is an essential retirement income supplement for many, but one thing is certain: Planning for additional sources of income to fund your retirement is important.

Following the government's advice, you might count on Social Security to provide about half of what you need to retire in reasonable comfort. The other half should come from other sources. Consider taking full advantage of tax-advantaged retirement savings accounts like a 401(k) or an IRA while you're still working.

Article Sources
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