The modern program of Social Security was established on August 14, 1935, by Franklin D. Roosevelt when he signed the Social Security Act. The program was created as mandatory social insurance designed to pay retired workers over the age of 65 or older a continuing income after retirement. Social Security has evolved into becoming the primary source of income for many retires, as well as an integral part of retirement planning.

The Social Security program operates by taxing employers and employees at a rate of 6.2% each on income. If one is self-employed, he or she will pay both portions of the tax for a total of 12.4% (not including Medicare tax). The money collected is put into a trust fund that pays monthly benefits to eligible retirees. In order to be eligible for benefits, one must have contributed to the system for at least 40 quarters or 10 years (which does not have to be all in one stretch of work). The amount of benefits one will receive is based on the average of the individual’s 35 highest-earning years. The higher the average, the higher the monthly benefit. This encourages workers to have at least 35 years of earnings because having one or more years of 0 earnings will pull down the average substantially, lowering the quantity of benefits to be received.

The earliest one can draw benefits is 62 years of age. However, those who meet the disability requirements defined by the Social Security Administration can receive benefits earlier. Disability requirements become less strict as the individual’s age. At age 62, one can only draw partial benefits (75%), and they are subject to a strict earnings limit; for every two dollars they earn over $17,640, they will lose one dollar in benefits. If one waits until they have reached full retirement at age 67, they will receive larger monthly benefits and have a much higher earnings limit of $46,920 (and a loss of $1 in benefits per $3 earned over that limit). If one decides that they do not need their benefits at age 67, they can defer their benefits until age 70, which will increase their monthly benefit payout at a rate of 8% per year of differed benefits. At age 70, there is no earnings limit and one must receive benefits as they cannot go any higher.

At age 70 ½, retirees are required to take their required minimum distribution (RMD) from their qualified investments. This is typically the age in which many mid to high-income individuals run into the social security “Tax Torpedo.” The Tax Torpedo refers to the sharp increase and then a sharp fall in marginal tax rates caused by the taxation of Social Security benefits. If retirees pass a certain income threshold, not including social security, benefits may be taxed at rates upwards of 50%, peaking at 85%.  Retirees who have large RMDs, as well as large social security benefits, are subject to higher marginal tax rates.   

Retirees with low incomes will not need to worry about the Tax Torpedo, and they may qualify for SSI or Supplemental Security Income depending on the severity of their situation. Disabled adults and children, as well as low-income individuals older than 65 and may qualify for these benefits. SSI benefits are typically enough to cover only the basic living essentials (i.e. food, clothing, shelter). Most retirees do not qualify for SSI; however, nearly all retirees qualify for Survivor benefits.

In the case in which a spouse dies, the surviving spouse is eligible for a Social Security survivor benefit as long as the couple had been married for at least nine months. The surviving spouse will receive the benefits of the spouse with the higher benefit amount. One can collect the benefit as early as age 60, but they will only be qualified for 70% of the amount that would be received at full retirement age (67). If one is disabled, the survivor benefit can be collected as early as age 50.  Surviving spouses and children are also qualified for a one-time lump sum $255 Death Benefit.

With all these seemingly arbitrary rules and guidelines, it is no wonder that many retirees decide to work with financial planners to help them work through all this complex information.