Social Security is one of the most important benefits programs in the U.S. It has played an instrumental role in keeping millions of seniors out of poverty. Many older Americans rely on it to provide a significant portion of their income after leaving work.
Despite its importance, it's also often misunderstood. Many people just don't really know how it works or what exactly affects the amount of money the program will provide. And that's understandable because a number of the rules are pretty confusing.
In particular, here are a few weird rules you might not know about that can impact the amount of Social Security income you have to live on as a retiree.
No matter how long you actually work, 35 years of earnings are always used to calculate your benefit
Your Social Security benefit is based on average wages. But not necessarily the average earned over your whole career.
No matter how long you have worked, Social Security calculates your average earnings based on the 35 years you made the most money (after adjusting wages throughout your career to account for inflation).
Because 35 years is always used, this means:
- If you worked less than 35 years, some years of $0 wages will become part of the 35 years of earnings used to calculate your average benefit. With $0 wage years, your average will be reduced and your Social Security checks will end up being smaller.
- If you worked more than 35 years, some of your lowest-earning years won't count. This can be beneficial if you've increased your salary over time. Higher-earning later years can push out lower-earning early years in your benefits calculation if you choose to keep working longer at the higher rate.
Understanding this is important because you may decide to put in a few extra years at work if you aren't happy with your earnings in any of the 35 years currently counting in your benefits calculation.
The threshold at which benefits become taxable isn't indexed to inflation
There's another really weird rule you should know about because it affects how much of your Social Security money you get to keep.
See, Social Security taxes benefits once your income goes above a certain threshold. If your provisional income (half your Social Security plus all taxable and some non-taxable income) exceeds $25,000 for single tax filers or $32,000 for married joint filers, you will owe the IRS tax on part of your benefits. That's not the weird part -- it's normal for higher earners to pay taxes lower earners don't.
What is surprising, though, is that these numbers are not indexed to inflation. Social Security has many provisions within it to allow for automatic changes to account for rising prices. For example, retirees get a Cost-of-Living Adjustment when a consumer price index shows costs are going up. And the amount of money subject to Social Security tax goes up each year.
But the amount you can earn before benefits become taxable has remained the same since taxes were first imposed on benefits. So, while originally fewer than 10% of retirees were taxed on benefits, now around half of all seniors lose some of their money to the IRS.
If you are, or will be, above these limits (especially as your income goes up over time to keep pace with inflation), you should plan for the taxes you owe to come out of your funds so you can budget accordingly.
Knowing these two weird rules is important so you aren't caught off guard with a lower-than-anticipated Social Security benefit. You don't want to be left with too little to spend, so knowing the truth can ensure you're prepared to supplement retirement checks from savings as much as needed to live the quality of life you deserve as a retiree.
