R101 #9 - Social Security
Social Security is complicated, y’all. That’s because a giant bureaucracy called the federal government got together with a complicated financial product called an annuity, and they had a baby named Social Security. It’s no wonder it’s complicated. There are entire software products dedicated to calculating the optimal Social Security strategy. There are entire books dedicated to explaining it.
Side rant - one downside to depending on a government program is that Social Security is now in trouble and subject to political whims. There are fewer active workers contributing to Social Security per retiree receiving benefits than there used to be. Depending on which government math you use, funding is “running out” at some point. There will need to be changes made to the program for it to continue intact. I won’t go into this more here, but it’s worth considering whether benefits will be paid as planned in the future.
The purpose of this blog post is to impress upon you what makes Social Security complicated, and the aspects of your personal situation that may make the decision less or more important to your personal retirement income plan.
So let’s start where we’ve started before in these posts - how funded is your retirement? If you have so much retirement income and/or assets that the optimal Social Security strategy won’t make a big difference, then you can ignore this topic. If you’re like most people, however, Social Security is an important part of your retirement income plan, and you need to take some time to understand it.
What risks are you most concerned about? Social Security can help address longevity risk, market risk, and inflation risk because it (theoretically) pays inflation-adjusted income for the rest of your life once you claim it. It can also provide income to survivors, dependents, spouses, and ex-spouses. Social Security benefits also receive preferential tax treatment. I mentioned in the last post that Social Security is the best annuity money can buy. This is what I meant. There’s no other annuity product on the market today that provides what Social Security does.
Why is it complicated?
During your working years, Social Security is easy. In fact, most people probably don’t even think about it, beyond checking out their annual statements and wondering if it will be there when they retire. Money is taken out of your paychecks (or paid via self-employment taxes) to fund the system. The first complicating factor is that you need to be eligible to receive it - 40 quarters of working credits for full benefits.
You used to get an annual paper statement that the Social Security Administration would send out. Now, it’s important for you to sign up and claim your account on https://www.ssa.gov/myaccount/. There are lots of good resources there for answering SS questions, and calculators you can run. You can also check your earnings history to make sure it’s accurate.
The second complicating factor is that what you put in, determines what you get out. Each person contributes a portion of earnings into Social Security each year. For years you earn $0, you don’t get credit for that year. There’s also a maximum earnings value over which you don’t have to contribute any more that year - for 2025 that amount is $176,100. (Clients love getting what I call the “Social Security raise” in their paychecks once they hit the max for the year, until January comes again and whomp whomp, you have to start contributing again.)
At any rate, the WAY simple explanation is that you get credits for each year you contribute, up to 35 years. Your highest 35 years are used for those who work longer than that. Replacing $0 years for those 35 years increases your benefit. Higher earnings in those years increases your benefit. Old earnings are indexed using inflation up to the value they would have at your age 60. The credits are turned into a Primary Insurance Amount (PIA) at Full Retirement Age (FRA).
The third factor is that your year of birth affects what your FRA is. For those born in 1960 and after, the FRA is currently 67. (It wouldn’t surprise me if this changes over time - Gen Xers don’t be surprised if we get screwed here!) For those born in 1959, the FRA is 66 and 10 months. For those born prior to 1958, the FRA is something less than 66 and 10 months. Y’all are already there, so congrats!
The fourth complicating factor is that your age upon claiming affects what you get. You get 100% of your PIA at FRA. Your PIA is recalculated each year for inflation (and earnings for the 35 included years). If you claim earlier than FRA, your benefit is adjusted downward based on how early you claim (earliest is 62) and your FRA (whether 66 or 67). If you claim later than FRA, your PIA is adjusted upward for waiting based on how long you wait between FRA and age 70. You get delay credits for waiting! But you also lose years of payments by waiting. Boooo. This is why the decision on when to claim is so important.
So, not only do you get additional benefits for waiting, the benefits are adjusted for inflation while you wait. You just don’t know how long you’re going to live, nor what inflation adjustments will be in the future. It’s impossible to calculate exactly how much better waiting is than not waiting. As a planner, I do my best to calculate it based on a reasonable inflation adjustment and a reasonable life expectancy. At some age in the future there is a breakeven point where waiting to claim leads to higher total lifetime benefits. If you don’t live that long, you should have claimed earlier.
The fifth complicating factor is that your other income affects how much you can get and how much is taxed. Lots of people are surprised that Social Security is taxed at all - it is at the federal level, and nine states also still tax it as of 2025 (surprisingly, California isn’t one of them!). Not surprisingly, there’s a special tax calculation that determines how much of your social security is taxed (from 0% up to 85%), but for the portion that IS taxed, it’s taxed at your marginal ordinary income rate. (We’ll talk more about taxes later.) I’m not going to go into the specifics of the income tax calculation, but the more ordinary income you earn while receiving benefits, the more of your Social Security that will be taxed.
One other dumb thing about having other income that I need to mention is that there is a thing called the Earnings Test for Social Security. It’s not really a TAX, but a reduction in benefits that happens if you are still working and earning income prior to FRA. After FRA, it goes away entirely. You may get additional benefits later to make up for those that were withheld, because your claiming age is adjusted upward, and it somewhat offsets the reduced benefit for claiming early. You could also replace $0 years included in your 35 years of benefit calculation, and that’s a good thing.
There used to be other rules for reductions in benefits for those who have certain pensions, but for now they’ve been repealed as of January 2025. If you see anything about WEP (Windfall Elimination Provision) and GPO (Government Pension Offset), that’s what they were.
The sixth major complicating factor is whether anyone else is impacted by your decision. For single people, the Social Security claiming strategy during retirement is complicated enough for all the reasons I list above. For those with spouses, dependents, disability benefits, or survivors, the claiming decision is even more complicated. Now you not only have to look at the primary worker’s benefit, but at benefits anyone else in their life may be eligible for now and into the future.
One more thing to mention - if you regret you claimed earlier than you should have, you have a couple of options:
You can withdraw your application within 12 months and pay everything back - allowed once in your lifetime.
You can suspend your benefits once you reach FRA (if you claimed before FRA, or were converted from disability benefits), and earn some delay credits.
You can work before FRA and the earnings test acts like a suspension.
What does all this mean to you - and what can you do?
Start with getting your most recent statement online. Check your earnings history and see if it looks reasonable and if there are any $0 years. The statement shows various projections of benefit amounts for different ages. You need to understand that they assume you work at your current income level all the way up until that age. For many people, that assumption is not accurate.
Your earnings may decrease (or increase!!) when you get near to retirement. You may stop working at 62 and not claim until FRA. Consider the numbers on the statement just a starting point. There are calculators on the SSA website where you can input different earnings assumptions and get a new estimate.
Next - start thinking about your claiming decision, whether it’s impacted by anyone else, and who yours may impact. As I mentioned above, for single workers, it’s less complicated. Remember that you could be eligible for benefits on your ex-spouse’s record if you’re divorced though. You may be pleasantly surprised that you’re eligible, but it can be harder to plan because it may not be easy to get estimates of what those benefits may be.
If there is more than one person involved in your claiming decision, I’d really recommend you find a GOOD online calculator that can help run a bunch of scenarios that can show you the impacts of various combinations of choices, or find a professional to help you. While the folks at the social security administration can be helpful with the logistics of claiming, they cannot provide advice on whether and when you should claim.
Finally, consider whether your financial situation will allow you to delay claiming past age 62/65/FRA. The stark truth is that a lot of people have to stop working in their early 60’s, and they don’t have other financial resources to use for retirement. If you have the luxury of being able to delay your benefits, you’ll need to start thinking about how to optimize your decision in the context of the rest of your financial plan. There are no shortage of planning opportunities surrounding this decision!
Last thought - Social Security and Medicare are not one and the same decision. We’ll talk about health insurance choices in retirement next.
