Social Security: What It Is, How It Works And Where Social Security Benefits Fit In Your Retirement Plan

Since 1935, the Social Security Administration (SSA) has been ensuring that qualifying American workers receive financial support during their retirement. But how are these retirement benefits determined, and what other support does the Social Security program offer to its beneficiaries?

Let’s take a closer look at what Social Security is, how it works, and what part Social Security benefits should play in your retirement.

What Is Social Security?

Social Security is a federal program administered by the Social Security Administration (SSA), an independent agency of the U.S. government. The program was created when President Franklin D. Roosevelt signed the Social Security Act into law on August 14, 1935.

Although its primary purpose is to provide a continuing source of income to retired workers and their families, the Social Security program also provides financial assistance to disabled workers, as well as the surviving spouses, children and dependent parents of deceased workers.

How Does Social Security Work?

The Social Security program collects regular contributions – in the form of a payroll tax – from wage and salary workers and their employers. Then 85% of these contributions are pooled into the Old Age and Survivors Insurance Trust Fund (OASI), which finances monthly benefits paid out to eligible retired workers.

Social Security Tax

The Social Security tax is 12.4% of your gross annual earnings up to a maximum taxable income of $147,000 (anything you make above that will not be taxed Social Security). However, your employment status determines how much of that tax rate you’ll have to pay yourself.

For example, if you’re currently employed by someone else, you’ll pay a Social Security tax of 6.2% of your gross, pre-tax income, and your employer will cover the other 6.2%. So if you make $90,000 a year, you’ll pay 6.2% of your entire earnings. However, if your annual salary is $160,000, above the $147,000 max (in 2022) you won’t have to pay Social Security tax for the remaining $13,000 of your salary.

If you’re self-employed, you’ll pay the whole 12.4% of your pretax earnings into the Social Security fund as part of your self-employment tax.

Eligibility

In order to receive Social Security retirement benefits, you’ll need to earn enough credits over the course of your working career.

In 2022, you receive one credit for every $1,510 you earn. You can only earn four credits in a single year, and you’ll need to accumulate at least 40 credits – or 10 years of employment – by the time you retire to be eligible for Social Security benefits.

If you stop working at any point in your career, you won’t lose the credits you’ve collected, and you can earn new credits to add to your existing ones when you resume working. However, you won’t begin receiving retirement benefits until you have at least 40 credits.

How Are Your Social Security Retirement Benefits Determined?

Your Social Security benefits are largely determined by two factors:

• How much you earn over the course of your working career
• How old you are when you retire

Lifetime Earnings

The calculation can get a little complicated, but the Social Security Administration will basically take the average of your highest 35 years of earnings to determine the monthly Social Security benefits you’ll receive once you retire. Obviously, a higher earnings average will result in higher monthly benefits.

When calculating your average earnings, the Social Security Administration will also perform a cost-of-living adjustment to index your income for inflation.

Retirement Age

Another factor that determines your Social Security retirement benefit is the age you elect to start receiving benefits. While you can choose to take Social Security at your full retirement age (more on this below) you can also elect to delay your retirement benefits or even start them early.

Full Retirement

When you reach full retirement age, you can begin receiving your Social Security retirement benefits in full – between 66 and 67 depending on the year you were born (up to 1959).

If you were born during or after 1960, you’ll need to wait until you turn 67 to draw your full retirement benefit.

Delayed Retirement

You can also wait to receive your Social Security retirement benefits, potentially increasing the amount of your benefits by:

• Increasing your lifetime earnings: By delaying, you’ll continue working, which means you can add extra years of income to your lifetime earnings. Depending on how much income you earn during those extra years, delaying your retirement could result in higher overall benefits.
• Adding percentage points to your retirement benefits: If you were born in 1943 or later, the Social Security Administration will increase your monthly benefits by 8% for each year from age 67 until you turn 70. After 70, your benefits won’t continue to increase.

Early Retirement

Similar to how you can delay your Social Security benefits, you can also elect to receive them as early as age 62. However, doing so will reduce your monthly benefit amount by as much as 20% – if you were born in 1937 or earlier – and as much as 30% if you were born in 1960 or later.

For example, if you qualified for a $2,000 monthly retirement benefit at age 67, but you were born after 1960 and decided to retire early at 62, you would only receive a monthly retirement income of $1,400 from your Social Security benefits.

Survivor Benefits

If you’re the spouse or child of a deceased Social Security beneficiary, you could qualify for survivor benefits. Persons eligible for survivor benefits include:

• Surviving spouses: Surviving spouses must be 60 or older – or 50 or older and have a disability – to receive survivor benefits. Surviving spouses who care for a child of the deceased who is younger than 16 or has a disability may also be eligible.
• Unmarried children: Any unmarried child of the deceased who is younger than 18 – or has a disability that was diagnosed before they turned 22 – may be eligible for survivor benefits.
• Other family members: Under certain conditions, a divorced spouse, adopted child, stepchild or grandchild may be eligible for survivor benefits – as well as dependent parents who are at least 62 years old and had relied on the deceased worker for half of their support.

Disability Benefits

In addition to providing funds in retirement, social security contributions also provide coverage for disabled individuals and their families. In fact, only 85% of Social Security contributions go toward paying out retirement benefits. The other 15% goes into the Disability Insurance Trust Fund (DI) to pay disability insurance benefits to eligible recipients.

You – and, in some cases, your family members – may be eligible for Social Security Disability Insurance (SSDI) if you have a physical or mental disability that prevents you from working.

Should You Rely On Social Security For Your Retirement Plan?

Most people will use about 70% – 80% of their pre-retirement income annually during your retirement. So let’s say your highest average income over your working career was $75,000. Ideally, you’d save enough for retirement to live on $52,500 per year.

As of June 2022, the average monthly Social Security check was $1,592.48, which rounds out to just over $19,000 annually. So while the Social Security program ensures that workers like you receive an income after they retire, you won’t want to rely solely on Social Security to finance your retirement – especially if you want to maintain your current standard of living.

If you haven’t already, you should consider investing in an IRA or Roth IRA, maxing out your contributions to your company’s 401(k) or 403(b) retirement plans and/or contributing to a high-yield savings account.

Not sure how much you have saved across all your accounts? You can easily link and view all of your investment and savings accounts using the net worth feature in Rocket Money. Get started here. 

Using A Mortgage Refinance To Invest In Your Retirement

If you’re looking to save more for retirement and own a home, you might consider refinancing to free up cash and increase your investments. You could use a traditional, rate and term refinance to lock in a lower mortgage payment so that you can make larger contributions toward your retirement. While you could technically use a cash-out refinance, this involves a lot of risk and is generally not recommended as an investment strategy. Everyone’s situation is unique so be sure to talk to a retirement planning professional before making any decisions.

The Bottom Line

For nearly 90 years, the Social Security Administration has helped qualified workers enjoy more financial stability throughout their retirement. That said, it’s unlikely that Social Security benefits will be enough to ensure you’re comfortable in retirement, making it important to invest in your 401k, 403b, or other investment account.  

Want to find out if a refinance is the right choice to help invest in your retirement? Start an application with Rocket Mortgage® today to speak with a Home Loan Expert and see what you qualify for.