The topic of Social Security is fraught with misinformation, which often prevents people from collecting all the money they've got coming to them. This article will shed some clarity on this often confusing subject, by debunking six common Social Security myths.
- The longer you wait to collect benefits (up to age 70), the higher they'll be.
- If you work while receiving Social Security benefits, your benefits will be reduced, but you'll get the money back later.
- A portion of your Social Security benefits may be taxable if you earn over a certain amount.
Myth #1: It's Best to Start Benefits as Early as You Can
Individuals may begin collecting Social Security benefits as early as age 62. Some cite the following two chief reasons for doing so:
- Those who don't truly need money to cover daily expenses can instead funnel this cash towards making investments, which may, in turn, grow their nest eggs even bigger, for when they reach their full retirement age (66 or 67, depending on birth year), and officially begin collecting. Those considering taking early benefits should weigh in several factors, such as inflation, current savings, health status, and probable longevity.
- Individuals should seize all the money they can, as soon as they're eligible because Congress could possibly enact legislation that scales back retirement benefits, to ensure that the system has enough funding for the long haul. On the other hand, if Congress actually moves forward in shrinking retirement benefits, there's a high likelihood that individuals who are at least 60 years old will be able to retain their existing payment models, where the Social Security Administration (SSA) calculates the average indexed monthly earnings (AIME), including the final year of indexing to the National Average Wage Index.
The downside to taking Social Security before full retirement age is that one's monthly benefits will be permanently reduced. For example, someone who starts collecting benefits at 62 will receive just 75% as much money each month as he'd receive if he'd waited until the full retirement age of 66. Those willing to wait even longer—up to age 70, when benefits max out—can receive even more each month.
"You definitely should wait until your full retirement age and not take Social Security at age 62 if you are still working," says Alexis Hongamen, CRPC, founder of Federal Retirement Investment Advisers, LLC, in Orlando, Fla. "You don't want to claim and have your benefit permanently reduced if you have any significant income from working a job."
Myth #2: You Will Reach ‛Break-Even’ Age in X Years
Some financial advisers ardently believe that 78 is the "break-even age" for starting Social Security. This essentially means that whether an individual begins collecting benefits at age 62, or whether he holds off until full retirement age, he'd ultimately pocket the identical total amount by age 78. After that age, those who waited until the traditional retirement age to collect would finally begin reaping higher payoffs, than those who elected to collect early.
Unfortunately, break-even age is a guess at best, because of the potentially changing variables behind the calculation, including the time value of money, and inflation rates. The break-even age is also impacted based on whether or not the benefit recipient is a worker or a non-working spouse.
"It is impossible to determine the best time to take Social Security without looking at your entire situation, particularly taxes, longevity, the current amount of retirement savings and life insurance," says Jason Glisczynski, CFP®, CAS®, investment advisor representative, Glisczynski and Associates, Inc., Plover, Wis. "If you are married you must examine the benefits, age difference, and longevity of your spouse. There is far more to the 'when do I file' question than just a break-even analysis. Everyone is different."
Myth #3: You Could Lose Benefits If You Work
When individuals collect Social Security, their benefits may be reduced by $1 for every $2 of earned income received above a certain threshold ($18,240 in 2020). This reduction continues until the year one reaches full retirement age. From then, until the month one reaches full retirement age, there's a reduction of $1 for every $3 earned over a different threshold ($48,600 in 2019). After that, an individual is entitled to earn as much as he or she wants, without triggering a reduction.
Let's assume that your job allows you to pull in $26,240 ($8,000 over the $18,240 limit). In this scenario, your Social Security benefits would shrink by $1 for every $2 you earn over the limit, for a total reduction of $4,000. Although it seems as though working hard is causing you to surrender benefits, in actuality, those benefits are technically just deferred, and will ultimately be credited to you on reaching your full retirement age.
Social Security benefits are adjusted each year for inflation, making them the only inflation hedge that many retirees have.
Myth #4: After Full Retirement Age, You'll No Longer Earn Social Security Credits
The majority of American workers are beholden to the Federal Insurance Contributions Act (FICA), a U.S. law that mandates a payroll tax on the paychecks of employees. The SSA recalculates an employer's primary insurance amount (PIA) every year. After your benefits begin, you'll be credited with one of your 35 highest indexed-earnings years. Therefore, provided you religiously pay your FICA (or self-employment tax, for those working for themselves) you may continually spike your benefits.
Although there is no downside to working after you start collecting benefits, "There is, however, a maximum benefit that can be received per worker per year and this amount is declared by the administration annually," says Jillian C Nel, CFP®, CDFA, director of financial planning, Legacy Asset Management, Inc., Houston, Texas. For 2020, the maximum full retirement benefit is $3,011.
Myth #5: Social Security Benefits Are Tax-Free
Many people don't realize that their Social Security benefits can be taxable if their income exceeds a certain amount. For example, in 2019, couples with a combined income between $32,000 and $44,000 who file a joint tax return will have to pay income tax on up to 50% of their benefits. If their combined income is over $44,000, they will owe tax on up to 85% of their benefits. The term "combined income" for this purpose means their adjusted gross income plus any nontaxable interest they received plus one-half of their Social Security benefits.
For example, consider a couple with a combined income of over $44,000 and total Social Security benefits of $3,000 a month or $36,000 a year. They would be taxed on up to 85% of half their benefits, or $18,000. That comes to $15,300. So if they're taxed at a marginal rate of 12%, they'll owe $1,836 in taxes on their benefits.
Myth #6: Social Security Benefits Are Eroded by Inflation
This myth likely stems from confusion over the way Social Security's annual cost of living adjustment (COLA) works. But one thing is for certain: COLA remains a key long-term planning booster for Social Security beneficiaries. Social Security benefits are annually adjusted for inflation, as measured by the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W).
In 2019, for example, recipients received a 2.8% increase in their benefits. In 2020, that COLA dropped to 1.6%. Some critics argue that the CPI-W isn't the best measure of how retirees spend their money, but it's what Congress has mandated.
Social Security is the only source of inflation-adjusted retirement income, for many retirees. Holding off on collecting benefits represents an effective method of maximizing payouts, especially for those without other income sources, such as pensions or annuities. The more time one waits to collect (up to the age of 70), the greater the COLA will be in dollar terms.
If you have questions about Social Security or would like to see what your benefit might be if you collect at 62, at full retirement age, or even later, visit the Social Security website or one of the SSA's local offices.