Social Security serves as a fundamental financial safety net for millions of Americans. Understanding the intricacies of how this system works is crucial for both planning for retirement and maintaining financial stability. This article aims to dissect the mechanics of Social Security and explain how it benefits retirees and other qualifying individuals.
How Social Security Funds Are Generated
Primarily, Social Security is funded through mandatory payroll taxes. These compulsory contributions are instrumental in building trust funds that are later utilized to disburse income to retirees and other qualifying individuals.
On your paycheck, a particular deduction labeled FICA (Federal Insurance Contributions Act) represents a combined payroll tax for both Social Security and Medicare. A total of 12.4% of your income, up to a specified limit, is paid into the Social Security system each year. This ceiling is subject to periodic adjustments for inflation; as of 2016, the limit was $118,500.
If you're an employee, your employer shares this burden by paying half of this contribution. These collective contributions ultimately cater to the Old-Age, Survivors, and Disability Insurance (OASDI) benefits provided to Americans.
Trust Fund Surplus and Treasury Bonds
When Social Security collects more in a given year than it disburses, the surplus isn't left idle. This excess amount is used to purchase U.S. Treasury Bonds. These bonds serve a dual purpose: they guarantee a rate of interest to the trust funds and allow the government to utilize this surplus for its expenditure in the interim.
Distribution of Social Security Benefits
While retirement income is the most common form of social security benefits, the program also covers disability benefits, known as SSD or SSI in some cases. In the event of the contributor’s death, spouses and minor children may be eligible to receive their Social Security checks.
Strategic planning can help married couples maximize their Social Security payout in retirement. Each spouse may have their own benefit and a spousal benefit available to them if they both contributed to the FICA taxes before retirement. However, it’s essential to remember that only one benefit can be paid to each living person.
Calculation and Taxation of Social Security Benefits
The amount of Social Security benefit you receive depends on several factors, including your earnings history, the age at which you begin claiming benefits, and more. Benefits can be claimed as early as age 62 at a reduced rate or deferred until age 70 for a significantly larger payout.
Benefits also increase due to Cost of Living Adjustments (COLA). However, these benefits can be taxed as income if a retiree or a married couple has a high enough taxable income in retirement.
While this article offers a broad understanding of how Social Security works, there's more to explore. By gaining a comprehensive understanding of this system, individuals can plan better for their retirement and ensure financial security in their golden years. Future articles will continue to demystify the intricacies of this crucial financial system, ensuring readers are well equipped to make informed decisions.
Summary
Social Security uses mandatory payroll taxes to grow trust funds that are used to pay income to retirees and other qualifying persons.
Any surplus that is collected in a given year and not paid out is used to purchase Treasury Bonds, which pay a guaranteed rate of interest to the trusts and allows the government to use this surplus money in the meantime.
When you receive your paycheck, you’ll see a deduction for FICA (Federal Insurance Contributions Act), which is a “combined payroll tax” for both Social Security and Medicare.
A total of 12.4% of your income is paid into the Social Security system each year; if you are employed by someone other than yourself, half of this contribution is paid by your employer. Income over $118,500 is not included in this calculation (as of 2016). Social security trust funds cover the needs of the Old-Age, Survivors, and Disability Insurance (OASDI) benefit provided to Americans.
The most common way social security benefits are paid is as retirement income, but millions of Americans also receive disability benefits, known as SSD or SSI in some cases. Spouses and minor children can receive a person’s social security check if they die.
Married couples sometimes use strategy to get the maximum social security payout in retirement, since each spouse may have their own benefit and a spousal benefit available to them, if they both were working and paying FICA taxes before retirement. Only one benefit can be paid to each living person, however.
There used to be a popular “file and suspend” strategy for married couples, but this was eliminated in 2016. Social security benefits can be taxed as income if a married couple has a high enough taxable income in retirement.
People can see what their benefit will be at normal retirement age (currently 67 for most working Americans), and use online calculators to see what their reduced benefit would be as early as age 62 (which would be 70% of your full benefit amount at normal retirement age).
A person can wait until age 70 to take their Social Security Benefit, and this will result in a benefit about 8% higher for each year it was deferred past normal retirement age. Benefits also increase for Cost of Living Adjustments (COLA).
There is, of course, more to know, and we’ll try to fill in the gaps in the following articles.
Am I Eligible for Social Security Benefits?
Can I Start Collecting My Social Security Benefits If I’m Still Working?
When Will Social Security Go Bankrupt?