Whether you are thinking about retiring in the near future or you think it’s a long ways off, it’s never too early to start retirement planning. With nearly 60% of retirees depending on Social Security as a major source of retirement income, it’s important to get a handle on Social Security basics.
Here are the three most common questions:
1. How is your Social Security Benefit amount determined?
To determine how much you will receive at retirement, the Social Security Administration applies a benefit formula using your average monthly income from your 35 highest-earning years. The higher this is, the higher your benefits will be.
2. When should you take Social Security based on your retirement planning strategy?
Deciding when to take Social Security benefits is one of the most important decisions one will make for retirement. You may either base the decision strictly on monetary benefits, or your decision may be more personally based.
The important question is when to start taking benefits, taking early retirement at age 62, or waiting for a later date. The answer is different for everyone, as it depends on various factors such as health, lifestyle, and marital status.
If you elect to receive them earlier, then your monthly benefit is reduced for each month short of your full retirement age. Conversely, if you wait until turning 70, then you're entitled to delayed retirement credits, which increase your benefits by 8% for each year of deferment, capping out at a total of 32%.
So how do you decide what makes sense for you? A break-even analysis can be a great tool to help you decide. This type of analysis can show you how long it takes to break even if you were to delay Social Security benefits, vs. claiming early or at full retirement age.
To calculate your breakeven point, start by adding up the total payments you receive over the years if you claimed early. Then divide this amount by the difference of the higher monthly benefits you'll receive if you delayed.
Here is a hypothetical example:
Monthly benefit at age 62 - $1,050 X 12 months = $12,600 annually
Monthly benefit at age 67 - $1,500 X 12 months = $18,000 annually (this is $5,400 higher than at age 62)
If you retired at 62, you would receive $63,000 ($12,600 X 5 years) that you wouldn't have received had you waited until age 67.
To make up for the $63,000 missed, you'd need to receive this extra income for 11.7 years ($63,000/$5,400).
So, you would break even 11.7 years after your 67th birthday at age 78.
The math differs depending on your specific benefits and how early you claim or how long you delay. But understanding the age at which you break even can be a great way to guide your decision.
3. Is Social Security Taxable?
Depending on your income level, your Social Security benefit may be subject to taxation. The chart below illustrates how your combined income (adjusted gross income + your nontaxable interest + one-half of your Social Security benefit) can impact whether your Social Security retirement benefit is subject to taxation.
This potential income tax exposure may have substantial implications for whether you choose to work in retirement, how your assets are invested, and the timing of withdrawals from other retirement accounts.
For instance, a withdrawal from a traditional IRA may lift your income beyond the thresholds described above, subjecting a higher proportion of your Social Security to income tax. The same is true of investment earnings in non-retirement savings. Retirees who have investment earnings in excess of their current spending needs may be subjecting their Social Security income to taxation.
Just a note - If you’re younger than full retirement age, and earn more than certain amounts, your benefits will be reduced. The amount that your benefits are reduced, however, isn’t truly lost. Your benefit will increase at your full retirement age to account for benefits withheld due to earlier earnings. Click Here For more information.
Need to get a handle on your retirement planning and curious about your own outlook? We are here to help you develop a plan!