The Basics of Social Security Benefits
Most working adults generally have two basic questions
concerning Social Security benefits. How much will I draw at retirement if the
system works? Will the system still be there when I retire? Let’s take a look
at these two questions.
How
much will I draw at retirement if the system works?
You must meet certain criteria to draw Social Security
benefits. First, you must accumulate 40 work credits during your working life.
You earn one work credit for a certain dollar level earned each year. That
amount changes from year to year ($970 for 2006). You can earn a maximum of 4
credits per year so most folks meet the 40 credit requirement after 10 years of
work.
Secondly, you take the average of your highest 35
years of earnings. These years don’t have to be consecutive but $0 earnings
years pull down the average. Earnings years before you reached age 60 are
adjusted for inflation. This average
earnings amount is multiplied times a percentage based on your prior earnings level.
Since Social Security is designed to protect lower income wage earners, they
receive a higher percentage of their average than higher income wage earners.
Third, you receive a certain percentage of the
calculated benefit depending on the age you start to withdraw. You draw the highest benefit if you wait
until age 70 and the lowest if you start at age 62. For most folks the best age
is what is known as “full” retirement age which falls between age 65 and 67.
Here is how it works. If you take “early” retirement
(before your “full” retirement age) you are penalized. For the first 36 months
that amounts to 5/9ths of 1 percent per month; then 5/12ths of 1% for each
additional month. Not only that but you must pay back excess benefits if you
earn over a certain level ($12,480 for 2006). If your full retirement age is
66, age 62 benefits would be approximately 75% of your full retirement benefit.
At full retirement you can earn an unlimited amount
without having to pay back excess benefits. You may have income tax on your
benefits however. If you wait until after your full retirement age your
benefits will increase 8% per year until age 70. You should consult your CPA or
financial advisor to assist in optimizing the right time for you based on your
personal circumstances.
The Social Security Administration will provide you
with a benefit estimate each year so you will not have to compute this yourself
but an understanding of the method may help you maximize your benefit.
Will
the system still be there when I retire?
This is Regis’ $1,000,000 question. Although the
Social Security system was designed as a “pay-as-you-go” system, we seem to be
going faster than we are paying. According to the “best guess” assumptions of
the Social Security Administration, the Trust Fund surplus will peak in 2028. The
fund will then begin a steady decline until it is exhausted by 2042. If no
other changes are made in the interim, benefits would then have to be reduced
by 27%. In 2078, they would have to be reduced another 32%.
What are some of the solutions? One could be a total
system change. Privatization and private accounts are touted as alternatives.
As far as the current system goes there are several ways: an immediate infusion
of $3.54 trillion; increasing the payroll tax rate from its current level of
12.4 up to 14.3%; or by reducing currently scheduled benefits 12.6%.
Politicians don’t want to address the problem; it is
too politically dangerous. But they won’t let it go broke either (opinion).
That is equally politically dangerous. It is always prudent to plan for your
own retirement benefits but Social Security will likely be there in some form
to supplement your plans.
Jim W. Norman, CPA, PFS is a principal
with Norman, Johnson & Co., PA, a
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