Social Security provides a wide range of benefits to American citizens that meet specific eligibility criteria. Benefits include retirement, disability, benefits for survivors of a family member who has died, and supplemental benefits.
You may be wondering, “how does Social Security work?”. Social Security is funded by payroll taxes. Employers and employees each pay 6.2 percent of wages up to the taxable maximum of $160,200 towards social security. Understanding what makes up your Social Security benefits is key to ensuring that your retirement planning is optimized.
Continue reading to learn more about your eligibility and benefits.
Eligibility for Social Security Benefits
Who is eligible for Social Security benefits? In general, individuals in the following categories can claim Social Security benefits:
- Retired workers and dependents
- Disabled workers and their dependents
- Survivors of deceased workers
Social security uses a credits system to assess if you qualify for each type of Social Security benefit. Credits correspond to your income earned during the year. When you work and pay Social Security taxes, you can earn up to a maximum of four "credits" per year. Generally, 40 credits is the magic number that qualifies you for most Social Security benefits. However, there are specific exceptions.
You can make the 40 credits needed for retirement benefits in 10 years. It isn’t essential to work all year to earn four credits, though. Credits are gained based on your earnings, not your time worked. In 2023, one credit is acquired for every $1,640 earned, with annual incomes of $6,560 resulting in the full four credits for the year.
The number of credits needed for disability and survivor benefits can be lower depending on the age at which the disability started or when the eligible family member died.
Types of Social Security Benefits
There are four different types of Social Security benefits that individuals can be eligible for:
- Retirement benefits: This is the most commonly claimed and best-known Social Security benefit. Retirement benefits are available from age 62 at the earliest (although note that fewer benefits will be received than if you wait until the full retirement age of 67, as we previously explained). Retirement benefits are to help increase your income during post-retirement years.
- Disability benefits: As you would expect, disability benefits are for people unable to work because of disabilities. Unlike the retirement age, where the number of credits to qualify is fixed, disability benefit requirements vary based on your age at the time of disability.
- Survivor benefits: This benefit type helps the survivors of retirees and workers. Survivors are typically considered to be widows and widowers, divorced spouses, and children.
- Supplemental Security Income (SSI): SSI is in place to help support those who can’t earn a wage on their own. This includes adults and children with disabilities and elderly people. SSI receivable depends on your work history.
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How Social Security Benefits are Calculated
There are multiple factors that determine how Social Security benefits are calculated, including length of time worked, earnings, age of claiming benefits, and more. A unique Social Security calculation formula determines exactly how much Social Security is due.
The Social Security formula takes an average of your highest 35 earning years, adjusted for inflation, and applies an indexed amount to consider the impact of inflation over that period. This is referred to as your average indexed monthly earnings, or AIME. Amounts are also impacted by the age of claiming Social Security and family circumstances.
There is a maximum benefit that you can earn through Social Security, and this maximum depends on the age at which you choose to receive your benefits. The maximum amount for 2023 is $2,572 if you take benefits at 62, increasing all the way up to $4,555 if you claim benefits at 70.
Cost of Living Adjustments (COLA)
A Cost of Living Adjustment (COLA) is an adjustment made to Social Security payments to contribute to the rising cost of living. Increases in the cost of living, also known as inflation, mean that prices for goods and services are now more expensive than before.
COLA adjustments vary year by year, and the adjustment required depends on the Consumer Price Index, a measure of the average change over time in the prices paid by US consumers for a set amount of goods and services.
Congress introduced the COLA adjustment in 1975 as a response to the increased cost of living, and annual COLA adjustments have been in place since this date. The COLA adjustment for 2023 is 8.7%. While 8.7% isn’t as high as rates in the 1970s and 1980s, it is a lot higher than previous years, with 2021 COLA being 1.3% and 5.9%. This means that if you received $1,000 of benefits in 2022, the same benefits mean you would receive $1,087 in 2023.
Taxation of Social Security Benefits
Taxation of Social Security benefits was introduced in 1983. The amount of tax payable on Social Security income depends on the total income, including income from sources other than Social Security. You won’t have to pay any tax if you have no income other than Social Security income. However, if you have even a little income from elsewhere, you’ll likely have to pay some tax. The bands for what amount of your Social Security income is taxable on individuals are as follows:
- Total income lower than $25,000 – none of your benefits are taxable
- Total income is between $25,000 and $34,000 – up to 50% of your benefits are taxable
- Total income is greater than $34,000 – up to 85% of your benefits are taxable
The following bands apply to couples that file a joint return:
- Total income of up to $32,000 – none of your income is taxable
- Total income between $32,000 and $44,000 – Up to 50% of your benefits may be taxable
- Total income greater than $44,000 – Up to 85% of your benefits may be taxable
Other adjustments will be factored in when calculating exactly how much tax is payable on Social Security income. Among other adjustments, survivor benefits and SSI are not included when calculating your taxable income.
How to Apply for Social Security Benefits
When you think the time is right to apply, you will need to provide the following documents:
- Proof of US citizenship
- Birth certificate
- Social Security card
- Prior year W-2 or self-employment forms
- Military service papers (if applicable) for people who served before 1968
- Bank information for the bank that you want to receive benefit payments in
- Any applicable marriage, divorce, or death certificates
- The above details are also required for people applying for spousal benefits
After collecting all of the required documents, you will need to set up an online Social Security account. Many people will already have an account, but you need this to proceed. Once this is set up, it is as simple as completing a Social Security application form. This form can be completed online or in a Social Security office.
Once you have submitted your application and it is accepted, you can expect to receive your first Social Security payment around two months after submission.
Social Security benefits can be complicated to understand, but the fundamentals are easy to grasp. Social Security benefits are available for US citizens who have qualified by earning enough credits throughout their working life. There are four main types of Social Security benefits; retirement benefits, disability benefits, survivor benefits, and supplementary security income.
In many cases, Social Security income makes up a large amount of retirement income for Americans, so understanding what is available to you is crucial. Ensure that you plan your retirement income in advance, especially giving careful consideration to the best age to start claiming benefits.