A Primer on Social Security
When planning for retirement you should think about all of your different sources of income- your IRA, an after-tax savings account, a possible pension, of course your 401(k) and Social Security. Estimating your benefits, especially for those close to retirement, is an important part of preparing for retirement. Our goal in this piece is to discuss the Social Security program, and how it will play into your retirement plan.
The Social Security program is set up as a pay-as-you-go system. The money you are putting in today is paid out to retirees already receiving their monthly benefits. In 2008, Social Security taxes are only applied to the first $102,000 you earn. Every paycheck you receive has a deduction taken out for Social Security taxes, at a rate of 7.65 percent. Your annual income is tracked by the Social Security Administration and a Social Security statement is sent out every year about three months before your birthday. You can compare this information to your past W-2’s or tax returns and report any discrepancies to 1-800-722-1213.
Eligibility is determined by a credit system and you will become eligible for retirement benefits when you earn 40 credits. In 2008 you earn one credit for every $1,050 of earned income (four credits is the max you can earn in one year). So that means it typically takes ten full years of employment to earn enough “credits” to qualify for benefits. Benefit calculations are based on average earnings over your lifetime. For most of us, the amount of your Social Security benefit is calculated by averaging the earnings from your 35 highest income-generating years. The years in which you have low or zero earnings are still used to get the total years of working up to 35. According to the Social Security Administration, the average monthly retirement check in 2007 was $926.90 (approximately $11,000 annually) and the highest was $1,793.61 (or $21,500 annually). In addition, Social Security adjusts the amount you receive for the increase in cost of living (2007 cost of living increased 2.3 percent). Your Social Security statement will give you an estimate of your benefits in today’s dollars or you can go to www.socialsecurity.gov and use one of their benefit calculators for an estimate.
Some individuals will need to pay federal income taxes on their Social Security benefits. This happens when you have other income that is reportable, such as wages, interest, dividends and other taxable income, such as withdrawals from your 401(k) or IRA. Your benefits will be taxable, but according to the IRS, no one will pay federal income taxes on more than 85 percent of their Social Security benefits. If you file your taxes as an individual and you make between $25,000 and $34,000, or if you file a joint return with an income is between $32,000 and $44,000, you may have to pay taxes on 50 percent of your benefits. If you make more than $34,000 for an individual or more than $44,000 for a joint return you may have to pay up to 85 percent. Payment options for your taxes include quarterly estimated tax payments to the IRS or you may choose to have federal income taxes directly withheld from your benefits. As always, you should consult a tax advisor when planning and estimating your future taxes.
When calculating how Social Security affects your retirement income, you must first figure out how much you’ll receive and then figure out when your monthly checks will start to arrive; this information is based on your birthday. For all those born before 1938, your full eligibility date is your 65th birthday. If you were born between 1938 and 1942 your eligibility date increases two months per year. Those born between 1943 and 1954 are eligible for full benefits at age 66. People born between 1955 and 1960 are on a graduating scale that increases two months per year while those born after 1960 are eligible at 67. You may apply for early retirement at age 62, but keep in mind when planning your future income that your monthly benefits will be lower than if you waited until your full retirement age.
This year, three and one-third workers will pay into the system for each retiree receiving their monthly benefits. The Social Security administration estimates that in the year 2034 there will only be 2.1 workers paying into the system for each retiree receiving benefits. So what does that mean? The biggest factor affecting the worker/retiree ratio is the size of the “Baby Boomer” generation. Seventy-six million American children were born between 1945 and 1964. Right now the “Boomers” are just beginning to enter retirement; most of them are still working. With those paychecks still paying into the system and a smaller group of retirees receiving benefits the disparity between retirees and workers is lower. By 2034, there will be almost twice as many Americans receiving benefits as today -- from 38.6 million today to 74 million. In regards to the future of the program, in 26 years the youngest “Baby Boomer” will become eligible for benefits. By that time, the Social Security system of today will have been tested, tried and hopefully reformed as the “Baby Boomer” generation, a generation of 76 million individuals, enters retirement and draws on the benefits deserved.
Most believe that Social Security needs to be reformed in order to accommodate for the changing demographics of the U.S. population. If the current system is not reformed, by 2041, Social Security benefits being paid out will be more than the system is taking in. While we cannot predict the future we expect the younger generations to be the most affected by any changes. For this reason we will recommend that you utilize your 401(k) plan and IRA options to better prepare for the future and to take personal responsibility for your finances. If you would like more information on savings or what to do/not to do with your 401(k), please check out our other articles on the Smart 401(k) Insights page.
For further information visit: http://www.socialsecurity.gov