Understanding Social Security benefits 

Your clients will often wonder whether they will have enough money to sustain them through their less productive years, especially if they become disabled or develop a chronic illness. This is a big cause for worry, and that’s why the government created Social Security benefits.  

Your clients may raise many questions when it comes to Social Security benefits, and rightly so. They might wonder: 

• What is Social Security?  
• How does it work? How is it calculated?  
• How much Social Security will your clients get? 

In this article, InvestmentNews sheds some light on these and other important questions that you or your clients may have about Social Security.  

Introduction to Social Security 

For starters, the term “social security” is a layman’s term for Old Age, Survivors and Disability Insurance or OASDI. OASDI is the official name for Social Security in the US.  

This government program's main purpose is to partially replace the income that a taxpayer loses when they age. It is also meant to help a surviving spouse (or their qualifying ex-spouse) or participants who have a disability. The operative word is “partially”, since Social Security benefits were never designed to provide its beneficiaries with 100% of their employment income.  

Social Security benefits are managed by a federal agency called the Social Security Administration (SSA). 

These benefits are meant to provide: 

• Survivor benefits 
• Retirement benefits 
• Income for disabled workers 

How does Social Security work? 

Social Security works like a 401(k) in that it is funded through an individual employee’s salary.  

Workers fund their Social Security by having a small portion of their salaries withheld. As for self-employed workers, they fund their Social Security by paying Social Security taxes whenever they file their federal income tax returns. 

The main difference is that a 401(k) plan is an investment tool meant for retirement savings, while Social Security works more like an insurance plan. The money that goes into Social Security funds two distinct trust funds:  

• OASI: Old-Age and Survivors Insurance Trust Fund (OASI) for retirees  
• DI: Disability Insurance Trust Fund for disability beneficiaries  

The two funds are used to pay out benefits to those currently eligible. Any money that isn’t spent stays in the trust funds to sustain its growth and guarantee its existence for years to come. 

What are Social Security credits and how do they work? 

Social Security credits are how the US federal government funds individual taxpayers’ Social Security benefits. This is a system where dollar amounts are converted into “credits” that have an equivalent value in real money. No worker can earn more than four credits per year for their Social Security.  

Any employee that completes a year of work at their employer earns four credits. The dollar value of each credit varies. In 2023, for instance, a Social Security credit was worth $1,640. In 2024, it’s pegged at $1,730. The increase in the credit value is to account for yearly average increases in wages.  

While these are the typical amounts, the actual amounts that beneficiaries will receive can vary. There are certain rules that apply for retirees, surviving spouses and children, and disabled workers.  

Whenever a worker earns a credit in 2024, the US government sets aside $1,730 for that worker and adds it to their Social Security benefits. The credits an employee earns do not change, even if they switch jobs or have gaps in their employment. They also do not earn credits if they are unemployed.  

How much will I receive from my Social Security benefits when I retire? 

While the federal government has pegged the credits workers can earn for their Social Security, the amount can vary depending on: 

• the worker’s age 
• their age when they retire 
• their income 

The main basis for the amount is the individual worker’s Average Indexed Monthly Earnings (AIME). This pertains to the past 35 years when the worker earned the highest amounts. This is why Social Security benefits can vary widely.  

As of the SSA’s September 2023 statistics, the average monthly Social Security benefit was $1,841 or $22,092 per year. Calculating a worker’s Social Security benefits depends on these factors:  

• the individual’s earnings over their lifetime 
• the age they choose to begin taking their benefits during their Full Retirement Age (FRA) or past that age 
• whether they are eligible to receive their spouse’s benefits, or their own benefits 

The FRA in the United States is 66 years and two months for those born in 1955, increasing gradually to 67 for those born in 1960 or later. 

Retirees who chose to retire at age 66 and 67 have their annual amounts increase by 8% for every year that they choose to delay their retirement benefits, until they reach 70.  

The Primary Insurance Amount (PIA) is the benefits amount paid to a worker once they reach their FRA. To calculate a retiree’s PIA, the government imposes certain percentages (called “bend points” by the SSA) on the highest earnings of the retiree.  

For this example, let’s assume that a worker’s top earnings for 35 years amounted to $1,750,000. Here’s how to calculate their monthly benefits:  

$1,750,000 ÷ 420 months = AIME of $4,167 

Now that we know the worker’s AIME, we can compute the PIA. To get this number, the federal government applies three different percentages on certain brackets:  

Bend points are brackets where the SSA takes percentages of the AIME to calculate the PIA.  

For 2024, the PIA calculation takes 90% from the first $1,174, 32% from amounts over $1,174 but under $7,078, and 15% of monthly earnings over $7,078.30. If the AIME amounted to $4,167, then the PIA would be $2,014.36.  

If a worker’s PIA appears insufficient against inflation, the government provides a hedge against this.  

To keep up with inflation, the government provides a yearly cost-of-living adjustment (COLA) for Social Security benefits. In 2023 It was 8.7% and will be 3.2% for 2024. 

For a better idea of what Social Security benefits will be like, you can also try free benefit calculators online. Just make sure you know your or your client’s highest earnings to get an accurate figure.  

Watch this video to know a bit more about how Social Security benefits work. The video also suggests ways to increase the monthly benefits you will receive upon retirement: 

Who is eligible for these retirement benefits? 

Three segments of employees qualify for Social Security retirement benefits: 

1. Workers 

Employees or workers who have paid into the Social Security system consistently for at least ten years are eligible for early retirement. They can get their retirement benefits by the time they reach the age of 62.  

Those who are eligible can choose to postpone receiving benefits until their full retirement age of 66 or 67 (this depends on the retiree’s year of birth).  

Retirees who postpone receiving their benefits can get higher benefits every month; they can receive even more if they wait until they turn 70. Social Security benefits do not go any higher than the amount they will receive at 70 if they choose to get these benefits past 70 years of age. 

Read more: How does early retirement affect Social Security benefits?

2. Spouses 

Spouses of Social Security beneficiaries can also receive monthly benefits. Their benefits can be based either on their own earnings or their spouse’s earnings records. Even an ex-spouse who did not re-marry can also receive benefits if their previous marriage lasted for at least a decade. Spouses usually receive an amount equal to half the PIA of a retiree.  

3. Children of retirees 

The biological children of a retiree can also receive a portion of their parent’s benefits until they are 18.  

Benefits can go past that age if the child has a qualified disability, and/or is still a student.  

If the retiree happens to care for a child that is not biologically theirs, the child can receive benefits until the age of 16. 

Are my Social Security benefits taxable? 

Yes. Social Security benefits are deemed as taxable income. These are taxed only up to 85% of the amount. Individuals must pay these taxes when they file:  

• a federal tax return as an individual and the combined income is more than $25,000 
• a joint return if the individual and their spouse have a combined income of more than $32,000 

In this instance, "combined income” refers to adjusted gross income, interest income (tax-exempt) and half of Social Security benefits. 

Those who are married and file a separate return will likely have to pay taxes on Social Security benefits. 

The future of Social Security 

As birth rates decline and life expectancy rises in the US, some concerns have been raised about the sustainability of Social Security benefits. Due to some changes made to Social Security back in 1983, benefits remain payable to beneficiaries on time and in full until 2037. By then, trust fund reserves will have been exhausted.  

If that happens, income tax revenues can take on the burden of paying out Social Security benefits, but only up to 76% of scheduled payments. To address this problem, US Congress will have to step in and find other revenue sources for OASDI.  

The Social Security Board of Trustees suggests these measures to extend the Social Security trust fund reserves:  

• an immediate 13% reduction of benefits 
• an immediate increase in combined payroll tax rate to 14.4% 

It has been suggested that one or a combination of these measures can extend the fund’s ability to give full scheduled payments for the next 75 years.  

Given the uncertainty of life and the likelihood of rising costs of living, can a retiree in the US live on Social Security benefits alone? For many Americans who are retired, are surviving spouses or have a disability, it’s unlikely that Social Security benefits are or will be sufficient. Even as far back as 2016, it was found that many Americans will probably outlive their retirement funds.  

A good strategy is to know how much your client will potentially receive as their PIA when they retire, and determine what amount is sufficient to live comfortably. They shouldn’t rely on Social Security alone; suggest looking at other investments to boost your client’s retirement fund or retirement income.  

Read and bookmark our pages on retirement for tools and strategies to help set up your clients for their golden years.