How Does Social Security Work?

Social Security income should help you enjoy your golden years without worrying about money. Learn the answers to the top questions about this program.

Today, Social Security is the financial backing of most retired workers. The days of pensions are gone and many Americans have 401(k) accounts that are too small to get them through retirement. Just how does social security work?

Social Security income comes from the federal government. As of June 2019, almost 48 million retirees receive monthly Social Security benefits. Social Security benefits were originally meant to replace a portion of your income upon retirement. The amount of Social Security benefits you earn depends on your lifetime earnings and the age that you request benefits.

Believe it or not, Social Security benefits aren’t automatic. You must earn them by earning work credits throughout your lifetime. You may earn up to four credits each year that you work. In 2020, you earn one credit for every $1,410 you earn. You need at least 10 years (40 credits) in order to be eligible for social security benefits. You must also be at least 62 years old before requesting your social security benefits; however, if you take your benefits before age 65, your benefits become permanently reduced.

What is the Full Retirement Age?

The Social Security Administration provides benefits based on your full retirement age. Anyone can request benefits once they turn 62 years old, but there’s a benefit in waiting until you hit full retirement – you earn more benefits.

If you were born between 1943 and 1954, your full retirement age is 66 years old. Each year after that adds 2 months to the retirement age. For example, if you were born in 1955, full retirement age is 66 and 2 months and if you were born in 1959, it’s 66 and 10 months. Anyone born 1960 or later doesn’t reach full retirement age until age 67.

The Social Security Administration bases your payment on your average lifetime earnings, typically the last 35 years. If you didn’t work for a portion of that time, you have a $0 income for that year, which averages into the total lifetime earnings and decreases the amount you’ll get from social security.

Aside from your average earnings, the Social Security Administration takes into account your full retirement age and your claiming age. The full retirement age is between the ages of 65 and 67 years old. It depends on the year you were born. If you take your retirement benefits before your full retirement age, you’ll earn less income (there’s a penalty for early access) and if you delay retirement, you’ll earn additional credits (give yourself a raise once you take your social security funds).

What’s the Benefit of Delaying Retirement?

On average, those that delay retirement after the age of 62 will earn an 8% increase per year. This increase occurs between ages 62 and 70. The longer you wait to retire, the more you increase your earnings. The increase is calculated on a monthly basis, which means even waiting a few extra months can have a positive impact on your retirement earnings.

The Social Security tax rate is 6.2% on all earned income up to $137,700 per year. Your employer also pays 6.2% on your behalf. If you work for yourself, you pay 13.4% up to $137,700.

What’s the Maximum Amount you can Earn?

The maximum Social Security payout changes yearly based on inflation - in 2020, the maximum payout if you retire at age 62 is $2,265. If you wait to take your benefits, though, your benefits could increase as much as 32%.

Some people will pay taxes on their Social Security benefits. Typically, those that have ‘other’ income in addition to the Social Security income are subject to taxation. First, you must know your ‘combined income.’ This is your adjusted gross income plus nontaxable interest plus half of your Social Security benefits. Using this number, see how you fit in below:

If you file your taxes as an individual and have combined income between $25,000 and $34,000, you pay taxes on 50% of your Social Security benefits
If you file a joint return and have combined income between $32,000 and $44,000, you pay taxes on 50% of your Social Security benefits.
If your combined income exceeds $44,000, you pay taxes on up to 85% of your Social Security income.

Can you Still Work?

Even after you collect Social Security, you are able to work, but it may affect your earnings. If you have reached full retirement age, according to the Social Security Administration, you can work and not worry about reduced benefits. Before you reach full retirement age, though, the SSA reduces your benefits by $1 for every $2 in earnings above the limit. The 2020 limit is $18,240. That means if you make less than $18,240, it won’t affect your Social Security income.

During the year of your retirement age, the SSA reduces your retirement benefit by $1 for every $3 earned that exceeds the annual limit of $48,600 in 2020 until the month that you hit retirement age.

Yes, even spouses – even if they don't work – may be eligible for Social Security benefits if their spouse worked. In order for a non-working spouse to get benefits, their spouse must be receiving benefits. In addition, the non-working spouse must be at least 62 years old. It also benefits non-working spouses to wait until they hit full retirement age to get the full benefit.

Once you are two months away from the chosen retirement age, you can apply for your Social Security benefits online, over the phone or by visiting your local Social Security office.

If you have Social Security questions about your eligibility, or when you should take it, contact your local Social Security office. While you shouldn’t rely solely on Social Security income, it's a good part of any well-rounded retirement portfolio.