Social Security is undoubtedly one of the most important programs in US history as it helps to provide vital support to seniors. Unfortunately, many people have misconceptions about what Social Security can do for them when they retire. Discovering the truth can come as a huge shock, and it can leave you financially unprepared for retirement if you’ve made your plans based on wrong assumptions.
To make sure this doesn’t happen to you, learn the truth about these three shocking facts about Social Security now, while hopefully you still have time to take action to strengthen your retirement security.
1. Benefits are only meant to replace 40% of income
One of the biggest shocks many retirees face is the discovery that their Social Security benefits aren’t designed to provide enough income for retirement — and aren’t even close to that.
If you stop receiving paychecks, you will generally need enough income to replace about 80% of the money you received from your employer. But Social Security checks aren’t designed to offer that much. Instead, you get about 40% of the pre-retirement income from them, so you’ll have to get the rest of your money from other sources.
If you expect Social Security to cover more than that amount, you could run into a serious shortfall. Avoid this mistake by anticipating that you will need your nest egg to replace 40% of what you earned before leaving work and setting retirement goals accordingly.
2. You can lose up to 30% of your standard benefit if you apply for 62
It also comes as a surprise to many retirees that claiming benefits early can significantly reduce Social Security income.
You are entitled to a standard benefit or a basic insurance amount (PIA), which is based on what you have earned during your career. This standard benefit only becomes available when you have reached full retirement age (FRA). Your year of birth determines your FRA, and it is between the ages of 66 and four months and 67.
Every month you get a check before FRA will result in an early filing penalty. These penalties reduce the amount of your monthly checks for the rest of your life. The penalties are equal to:
- 5/9 of 1% during each of the first 36 months that you applied for benefits early.
- 5/12 of 1% during a previous month before.
These fines add up quickly. If you retire at age 62 while your FRA is only at age 67, your standard benefit will shrink by as much as 30%. This should be taken into account when deciding whether you should get checks ASAP when you qualify, or whether you should wait.
3. You may lose some of your benefits in taxes
Finally, many seniors don’t realize that both the federal and state governments could reduce their Social Security checks. It is normal to assume that this money is tax free because it is an earned benefit and you will get money back based on how much you have paid over the course of your life. But that is not always the case.
Your state may tax your benefits if you live in one of the 13 states. And the federal government will begin levying taxes once your provisional income reaches $25,000 as a single tax return or $32,000 as a married joint filer. Provisional income is half of your Social Security benefits, some non-taxable income such as MUNI bond interest, and all of your taxable income.
If you pay part of your benefit in taxes, you have less left to live on. And if you already receive a check that is smaller than expected, it can only exacerbate your financial problems.
Knowing these facts ahead of time can help you better prepare for your later years because you’ll have a better idea of how much Social Security income you’ll be getting — and how much extra money you’ll need to top it up.