Social Security Retirement Benefits Explained

Social Security is a government program that impacts everyone; however, there is much confusion and misunderstanding about it.

The confusion revolves around both sides: A: Understanding how Social Security contributions are deducted from your weekly paycheck, K-1, or self-employed income. B: Reaping the rewards at retirement age. In this post, we will clarify the unknown and explain everything you need to know so you get to learn how the process works. 

Social Security: Introduction and History 

Social Security is a federal program designed to provide financial support to individuals during retirement, as well as, to disabled workers and their families.

It acts as a safety net, ensuring that citizens have a source of income when they can no longer work due to age, disability, or death.

The Social Security program is funded through payroll taxes under the Federal Insurance Contributions Act (FICA).

During the Great Depression, countless Americans faced unprecedented financial distress. The unemployment rate reached 25%, savings had evaporated, and older people were particularly vulnerable, often finding themselves entirely without support.

President Franklin D. Roosevelt signed the Social Security Act into law on August 14, 1935, acknowledging the urgent need for a system to safeguard these at-risk populations.

Although the Act initially provided benefits to retired workers aged 65 or older, the program has expanded over the years to cover a broader range of individuals and benefits.

Today, Social Security includes retirement benefits, disability benefits, survivor benefits, and Supplemental Security Income (SSI), which aids elderly, blind, and disabled individuals with limited income and resources.

Paying in FICA Tax - Social Security 

To fund this program, a new class of taxes, known as FICA tax, was created, often referred to as Payroll Tax. The amount of tax will depend on whether you are an employee or self-employed. 

• As an employee, you contribute 6.2% of your earned income to Social Security, which your employer equally matches, bringing the total to 12.4%. An employee is someone who earns money on a W-2.
• If you are self-employed, you will be responsible for the full 12.4%, covering both the employee and employer portions. Self-employed refers to someone getting paid on a 1099 or income from an LLC. 
• Read here to learn more about the different categories of income.

There’s a ceiling on the income subject to this tax; for 2024, earnings above $168,000 are exempt. This cap adjusts and increases annually.

Paying in FICA Tax - Medicare 

The Medicare tax is meant to cover hospital, nursing home care, doctor visits, and prescription drug coverage, helping to lower healthcare costs for seniors and disabled

individuals.

Employees and employers contribute 1.45% of their earned income to Medicare to pay for these benefits totaling 2.9%. If you’re self-employed, you pay the entire 2.9% Medicare tax.  

There are two other differences between Social Security and Medicare;

1. There is no income cap of $168,000 for Medicare Tax.
2. High earners may also be subject to an additional 0.9% Medicare tax on income exceeding certain thresholds.

FICA vs. Other Payroll Deductions 

While we’re on the topic of FICA tax, let’s observe and summarize all types of paycheck deductions and how they affect your income. 

Eligibility Requirements: The Credit System & Minimum requirements

To qualify for Social Security retirement benefits, you need to have earned income for at least 10 years, with a minimum of $6,920 per year (2024 figures). Following is a more detailed explanation of the requirements. 

• You need 40 credits to qualify for Social Security retirement benefits.
• You can earn a maximum of 4 credits per year.
• Each $1,730 earned gives you 1 credit.
• If you earn $6,920 or more in a year, you will receive the 4 credits for that year.
• If you earn 4 credits per year, you will reach the 40-credit requirements in 10 years.
• The $1,730 amount is based on 2024 numbers. The amount required to earn a credit is adjusted periodically based on wage trends.

Keep in mind that these numbers will give you some benefits, however they will be limited compared to the full potential benefits.

*The following table illustrates a rough estimate of how your earnings will affect your social security benefits. Your actual benefits depend on various factors.

What is considered income for Social Security?

Your income must be considered ‘earned income’ to qualify for Social Security benefits. Below is a list of income items and their category.

1. W2 Wages, tips, etc. - Earned Income
2. K1 from a S-Corp - Unearned Income
3. K1 from 1065/LLC - Only in some cases. Look for the amount in Box 14A.
   • Real Estate K-1 is generally unearned income.
4. Guaranteed Payment on K-1 - Earned Income. Look for the amount in Box 4
5. 1099-NEC - Earned Income
6. 1099-Misc - Unearned Income (Generally)
7. Schedule C - Earned Income
8. Schedule E (Real Estate) - Unearned Income

How to Maximize Your Social Security Benefits: 2 Key Factors.

Your Social Security benefits depend on two key factors: 1—your earnings history and 2—the age at which you begin receiving benefits. To maximize your benefits, focus on both factors: Contributing as much as possible and timing your claim. Start claiming and receiving benefits at the most beneficial time.

Maximizing Benefits Through Earnings - the “35-Year” Rule

• Social Security calculates your benefits based on your highest 35 years of earnings.  
• If you have less than 35 years, “zeros” are added for the missing years, lowering your average earnings.
• The fewer years you have with earnings, the more zeros get added, reducing your overall benefits.
• Example: Suppose you have 35 years of earnings totaling $1,800,000. Dividing this by 420 months (35 years) gives you an average monthly earnings (AIME) of $4,285.71.
  • Note that this calculation is for illustration only. The actual math will include your Primary Insurance Amount (PIA)

Maximizing Benefits Through Earnings - Understanding the “Bend Points”

To understand how Social Security replaces your income, it’s important to understand the concept of  “bend points.” These are the thresholds that determine how much of your income will be replaced. Lower-income earners get a higher percentage replaced than higher earners.

For 2024, the bend points are as follows: for income up to $13,380, you will receive 90% of your money; for earnings of $13,380 up to $67,440, you'll receive 32%; and for earnings of $67,441 up to the social security limit of $168,000, you'll receive 15%. Any earnings above that limit are not considered when calculating your Social Security benefits.

Let's take the example of a person whose average annual income over 35 years is $170,000. This income is split across different segments (or bends) to calculate Social Security benefits. For income up to $13,380, 90% is applied, for the next $67,440, 32% is applied, and so on.

Social Security Benefits for Couples

• If both spouses work: Each spouse earns their own Social Security benefit. The lower-earning spouse can choose between their own benefit or 50% of the higher-earning spouse’s benefit—whichever is greater.
• If only one spouse works: The non-working spouse can still receive up to 50% of the working spouse’s benefit through a spousal benefit.
  

Maximizing Benefits Earning Through Optimizing Your Retirement Age

When deciding when to begin your Social Security benefits, the timing can significantly affect your retirement income. Your monthly benefit is based on;

1. Your Primary Insurance Amount (PIA). This is the amount you’ll receive at Full Retirement Age (FRA)
2. The amount is further adjusted depending on when you start receiving benefits.

Medicare Benefits 

As discussed, part of your FICA Tax goes to Medicare Insurance. You are eligible for Medicare when you turn 65. Here is a quick overview:

Medicare Part A (Hospital Insurance) covers hospital stays, skilled nursing care, hospice, and some home health care. You don't pay a premium for Part A if you or your spouse have earned 40 work credits.

Medicare Part B (Medical Insurance) covers doctor visits, outpatient care, medical supplies, and preventive services. You pay a premium for Part B, regardless of how many work credits you have. However, if you're low-income, you might be exempt. 

Other Social Security Benefits

In addition to retirement benefits, Social Security also provides important support through other programs.

1. Disability Benefits - Social Security Disability Insurance (SSDI) helps people who can’t work due to a serious disability. To qualify, you need to have worked enough and have a condition that meets Social Security’s definition of disability.

2. Survivor Benefits - Survivor benefits provide financial support to the family of a worker who has passed away. The benefits can go to a spouse, children, or sometimes dependent's parents, based on the worker's earnings, offering help after a loved one’s death.

3. Supplemental Security Income (SSI) - Supplemental Security Income (SSI) is a needs-based program that provides financial assistance to individuals who are aged, blind, or disabled and have limited income and resources.

   
   

   Unlike Social Security benefits, SSI is funded by general tax revenues and is available regardless of an individual’s work history, offering essential support to those with the greatest financial need.

Will Social Security be here in the future?

Although there is concern about Social Security’s future, it is unlikely to disappear. The program is too essential and widely supported for the government to simply eliminate it.

While Social Security faces financial challenges, the government has options to extend its funding. These include:

• Gradually raising the retirement age.
• Adjusting how benefits are calculated by slightly reducing benefits.
• Increasing payroll taxes.

Social Security: A Supplement, Not a Sole Solution

It is important to note that while Social Security provides a substantial source of income, it is not sufficient to rely solely on retirement.

Social Security is designed to supplement other retirement savings and income sources, such as pensions, personal investments, and savings accounts.

Depending only on Social Security may not meet all your financial needs and goals in retirement, making it essential to plan and diversify your retirement portfolio to ensure financial stability and comfort.

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