Most Americans watch their money go into the Social Security trust fund in the form of payroll deductions as soon as they begin working, when retirement seems a long way off. As a result, many go through their working lives without giving it much thought.
Here are a few facts everyone should know about Social Security benefits before making any decisions about retirement.
Who is entitled to retirement benefits?
Just about anybody who has worked for 10 or more years is eligible for Social Security retirement benefits.
“You need 40 quarters of employment, earning a minimum income of $1,120 per quarter,” says Brett Horowitz, principal and wealth manager at Evensky & Katz in Coral Gables, Fla.
The income requirement is so low that “it could be met with seasonal work,” says Richard W. Stumpf, principal at Financial Benefits in Wichita, Kan.
There are some exceptions. Most federal employees hired before 1984 aren’t eligible to participate, Horowitz says. Stumpf adds that pastors may choose not to pay in.
Also, railroad workers and their families generally get benefits through a separate retirement system
How are payouts calculated?
The size of your monthly check is arrived at by a series of calculations.
Your primary insurance amount, or PIA — the benefit you would get at full retirement age — determines the size of your monthly retirement check. According to the Social Security Administration’s website, the PIA is based on the Average Indexed Monthly Earnings, or AIME, as applied to an inflation-adjusted formula. The PIA is then adjusted for whether you take retirement before or after your normal retirement age — 66 for those now reaching retirement age, but gradually adjusted to age 67 for those born after 1954.
You can begin drawing reduced Social Security as early as 62. For every month you delay after reaching full retirement age, up to age 70, the monthly benefit increases.
According to a recent report of the Senate Special Committee on Aging, for someone with an AIME of $5,000 in 2009, the PIA would total $1,971.
In keeping with the original intent behind Social Security — a way to lift seniors out of poverty — lower-wage earners get a higher proportion of their earnings than higher wage earners. The maximum monthly benefit that can be received in 2010 is $2,346.
What are spousal benefits and widow benefits?
If one partner in a marriage earns significantly less than the other, the lower-earning spouse can collect spousal benefits rather than payouts based on his or her own earnings history.
“The spouse can get the greater of their own or 50 percent of the other spouse’s PIA,” Horowitz says. “The lower-earning spouse is not eligible until the higher earner starts getting benefits, but both can start as early as 62.”
Stumpf says this option can be a financial planning tool.
“Imagine a high earner whose spouse is his employee,” he says. “If they cut her pay and transfer the rest to him, when she reaches retirement age, one-half of his income will be significantly higher than what she earned.”
A divorced spouse who was married for more than 10 years and has not remarried can draw against the ex-spouse’s work history. Widows and widowers can receive the higher of their own or their spouse’s monthly payment, but not both.
“That’s why it’s important for the higher earner to delay taking benefits for as long as possible,” says Horowitz.
How broke is Social Security?
According to many studies, the
Social Security trust fund will be able to cover its
retirement and disability obligations for the next 30 years or so, after which there will be a shortfall of about 22 percent. The Senate Special Committee on Aging figures funds will fall short in 2037.
Stumpf thinks those estimates are optimistic.
“The Social Security trustees assume an annual 2.8 percent inflation rate,” he says. “Historic norms are in excess of 3 percent. That’s a big difference when you’re talking about trillions of dollars.
“We could make small adjustments now and bring it to fully fundable status; if we delay, it will be more painful. In 10 years the shortfall will be significantly bigger; in 20 years it will be through the roof.”
Where do payroll deductions for Social Security go?
In theory, they’re held in trust by the government. But it’s not as if your money sits there in the Social Security trust fund waiting for you to retire. After current beneficiaries are paid, surplus dollars are used to buy bonds from the U.S. Treasury. So the trust has the bonds, but the money is now in the Treasury, where Congress can use it for any purpose.
“The Social Security trust fund is … a piggybank holding paper IOUs from Congress,” Stumpf says.
This is the first year that Social Security has had to cash in one of those bonds in order to meet its payroll, says Stumpf.
“From this point forward, an increasing number of those bonds will have to be pulled out every year — and Congress is going to have to find a way to come up with all that money,” he says.
Retirement resources
For most people, Social Security is one component of retirement income — one leg of the so-called three-legged stool.
Pensions are another component, but these days few workers get a pension. The last leg would be personal savings, whether in a 401(k) plan, IRA, an investment account or savings account.
Read Bankrate’s Retirement Guide to learn basics about how to construct a retirement plan.
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