Social Security 101

Understanding the World's Largest Pension Fund

Social Security 101
February 4, 2014

Established in 1935, Social Security is effectively a national pension plan – although it's easy to start a spirited argument on what kind of pension it really is, and in some quarters, whether it is a pension at all. Social Security is generally considered a form of defined benefit pension plan, since your benefits are calculated based on your lifetime earnings. Technically, it is more than just a pension program, as Social Security also covers some disability and survivor benefits as well as retirement income.

You qualify for Social Security based on credits earned during your working life. You receive up to four credits per year, with one credit earned per increment of income (a very low number, slightly over $1,000), and 40 credits over a lifetime will qualify you for Social Security.

Essentially, working almost any full time job for at least ten years qualifies you for Social Security benefits – assuming Social Security taxes are deducted from your paycheck (or you paid Social Security taxes separately as an independent contractor). Deductions on your paycheck for both Social Security and Medicare show up as FICA (Federal Insurance Contribution Act) taxes.

    [Note: Certain groups of workers – including railroad employees, teachers, and some government workers -- are not covered by Social Security because they’re enrolled in other pension systems instead. In some cases, they may be able to draw reduced Social Security benefits as well as their pensions, but the rules are complex. If you fall into one of these worker categories, contact your local Social Security office for guidance.]

Your benefits are determined by calculating your Average Indexed Monthly Earnings (AIME) – indexing accounts for changes in overall wages during your time of employment. Your benefits are a percentage of your AIME. During your working years, you will receive a yearly summary from the Social Security Administration (SSA) of your earnings history, credits, and estimate of retirement benefits. Spouses may receive some or all of the benefits that their working spouse was due, depending on the situation.

When you are ready to collect benefits, you'll need to apply with the SSA, either online or at a local Social Security office. You can begin collecting between ages 62 and 70. Your "standard retirement age" differs based on your birth date. If you were born before 1936, it's age 65. If you were born after that, it increases in increments up to age 67, the retirement age for those born in 1960 or later.

Taking monthly benefits before your designated retirement age will reduce them substantially – the Social Security website contains a chart with details. For those born in 1960 and beyond, monthly benefits are reduced by as much as 30% -- and spouse's benefits are by as much as 35% -- when you begin collecting at age 62. Conversely, if you delay collecting past your standard retirement age up to age 70, you can receive a delayed retirement credit of up to 8% per month for every year you delay.

You can still work and receive social security benefits, within limits. From age 62 until one year before full retirement age, $1 in benefits is deducted for every $2 earned over an annual limit ($15,840 in 2014). In the year before, it's reduced $1 for every $3 and at a different limit ($41,400 in 2014). Afterwards, benefits are unaffected regardless of how much you earn.

You may have to pay taxes on your benefits, depending on your overall income. Below $25,000 total income ($32,000 for married couples filing jointly), your benefits are tax-free. 50% of benefits are taxable up to $34,000 ($44,000 for couples), then 85% thereafter.

Social Security benefits are not always straightforward, so before you retire, check the Social Security website, or contact your local Social Security office for advice on your situation.

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