Few areas of personal finance are as plagued by misinformation as Social Security. As a result, people often make decisions that keep them from receiving as much as money as they're entitled to. This article aims to debunk six major Social Security myths and set the record straight.
- 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
Age 62 is the earliest that you can collect Social Security benefits, and some "experts" may suggest you do so. There are two schools of thought behind this idea.
- The first is that even if you do not need the money to cover your living expenses, you should take it and invest it. Assuming you invest the money successfully, you might then have more money available down the road than if you had waited until full retirement age—currently between age 66 and age 67, depending on when you were born—to start receiving benefits.
- The second school holds that a bird (or a benefit) in the hand is worth two in the bush. The theory goes that you should take every dollar as soon as you can because Social Security retirement benefits (at current levels) may not continue much longer. This concept is based on a fear that Congress will scale back benefits to shore up the system's funding.
As for the first school of thought, when to start collecting Social Security benefits is a complex decision that should be personalized to each individual. It can involve many factors, including whether you can keep working, how much other money you have saved for retirement, the state of your health, and how long you expect to live.
The downside of taking Social Security before full retirement age is that your monthly benefits will be reduced, not just at that point but for the rest of your life. For example, someone who starts collecting benefits at 62 will receive just 75% as much money each month as they would have received if they'd waited until their full retirement age of 66. And if you can wait even longer—up to age 70, when benefits max out—you'll 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."
As for the fear-based argument, Social Security benefits are not guaranteed, and Congress can make any future changes it wishes. But for both political and practical reasons, it may be difficult to reduce the benefits of people who have already earned them by formula. For example:
- At age 60, your average indexed monthly earnings (AIME) are calculated by the Social Security Administration (SSA), including the final year of indexing to the National Average Wage Index.
- At age 62, you qualify for a primary insurance amount (PIA), which is your benefit, payable monthly at full retirement age.
The SSA has a significant investment in the technology and counseling resources behind these calculations, and Americans rely on them for retirement-planning security. So, even if Congress should decide to reduce benefits, it could grandfather in anyone who has already reached age 60, for example.
Myth #2: You Will Reach ‛Break-Even’ Age in X Years
Some financial advisers may make confident projections such as, "Your break-even age for starting Social Security benefits is 78." By this, they mean that whether you start benefits at age 62 or wait until full retirement age, you will receive the same amount in total by age 78. Only after that will the higher benefit you would receive by waiting to begin the payoff.
Unfortunately, break-even age is a guess at best, because the variables behind the calculation can change. They include:
- The discount rate or time value of money
- The rate of inflation
- Whether the benefit recipient is a worker or a non-working spouse
The permanent benefit reduction for starting early is greater for non-working spouses than for workers. Therefore, most non-working spouses can expect to outlive their break-even ages. You can also think of the discount rate or time value of money as the after-tax return you could earn by investing your after-tax Social Security benefits from age 62 through full retirement age. However, keep in mind that up to 85% of benefits may be taxable for higher-income recipients.
Finally, the break-even point usually isn't the most critical issue in making the start-date decision. If you don't need the income to support your lifestyle from age 62 through 66, it's generally best to wait unless health or other concerns mean that taking your money early makes sense.
"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. 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," says Jason Glisczynski, CFP®, CAS®, investment advisor representative, Glisczynski and Associates, Inc., Plover, Wis. "Everyone is different."
Myth #3: You Could Lose Benefits If You Work
It's true that if you work while collecting Social Security, your benefits will be reduced by $1 for every $2 of earned income you receive above a certain threshold ($17,640 in 2019). This reduction continues until the start of the year in which you reach full retirement age. From then until the month you reach full retirement age there's a reduction of $1 for every $3 you earn over a different threshold ($46,920 in 2019). After that, you can earn as much as you want, without any reduction.
Assume, for example, that you work and earn $25,640 ($8,000 over the $17,640 limit). Your Social Security benefits would be reduced by $1 for every $2 you earned over the limit, for a total reduction of $4,000.
But while it may appear that you are losing benefits by working, those benefits are actually deferred, and Social Security will credit them to your record when you reach full retirement age. There are good reasons not to start benefits before full retirement age, but this one isn't high on the list.
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 Won't Earn Any More Social Security Credits
Most workers and their employers are subject to Social Security, or Federal Insurance Contributions Act (FICA), withholding on earned income, regardless of the worker's age.
The Social Security Administration will automatically recalculate your primary insurance amount (PIA) every year that you work, and if one of your 35 highest indexed-earnings years is attained after you start benefits, you will be credited with a higher benefit. So as long as you work and pay FICA or SE taxes you can potentially keep increasing your benefit. There is no disincentive in the Social Security system for working after you start 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 2019, the maximum full retirement benefit is $2,861
Myth #5: Social Security Benefits Are Tax Free
Many people may not 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 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 arises from a lack of understanding of how Social Security's annual cost of living adjustment (COLA) works. Also, it may involve a belief that retired people have better inflation-hedging tools available to protect their retirement income.
In reality, the COLA is perhaps Social Security's most powerful long-term planning benefit. For an 85-year-old who started benefits 20 years ago, the cumulative COLAs over that time now provides a larger benefit, in inflation-adjusted dollars, than their original starting benefit.
Each year, all Social Security retirement benefits are adjusted dollar-for-dollar 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 2.9% increase in their benefits. (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.)
For many retired people, Social Security provides their only source of inflation-adjusted retirement income. A similar benefit is available only with some types of immediate annuity and pension payouts. For individuals who don't receive income from such annuities or pensions, maximizing Social Security benefits, by waiting to collect, can be one of the best ways to hedge their retirement income against the effects of inflation. The longer you wait, up to age 70, the greater your COLA will be in dollar terms because it will be multiplied against a larger base amount.
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.