• Hannah

Understanding Social Security

Updated: Jan 23

Before we get into it, I want to make the disclaimer that Social Security is a complex benefit, and this is by no means a comprehensive look at how it works. My aim here is simply to provide a basic understanding of the system so that you can ask the right questions when it comes time to integrate Social Security into your retirement plan.


When it was first implemented, Social Security was intended to be an income supplement for those experiencing hardship following the great depression and World War II. It was signed into law by President Franklin D. Roosevelt in 1935 as a form of social insurance. Over the years the program has expanded to include benefits for spouses, the disabled, and minor children of eligible recipients. (This expansion likely has something to do with the shortfall we’re currently facing - more on that in a moment). It was never intended to be the only source of retirement income for Americans.[1] This doesn’t mean that it’s not possible to subsist on Social Security in retirement. In fact, many do. A key part of this has to do with the cost of living which varies greatly from place to place across the United States. Social Security does not adjust based on the cost of living where you live. For someone living in California, Social Security is likely not going to be enough to provide for your needs in retirement. However, for someone living in portions of the Midwest or the South where the cost of living is lower, Social Security benefits tend to go a lot further. As we discussed earlier, a lot of that depends on your personal situation and what expenses you will need to cover in retirement. How much you will receive is also key.


Social Security retirement benefits are based on a credit system. You receive 4 credits for every year that you pay into Social Security from your paycheck. You need 40 credits to be eligible to receive Social Security which means you need to work – and pay into the benefit – for a minimum of ten years. Your exact benefit will be an average of your highest-paid working years (total up to 35). You can easily obtain an estimate of your benefits by going to https://www.ssa.gov/myaccount/ and setting up a My Social Security Account.


What’s the deal with the shortfall?

Excellent question – glad you asked. Social Security benefits are paid out from current earnings. In really simplistic terms, this means that a 70-year-old individual who is currently receiving benefits is receiving benefits paid for by someone currently working and paying into Social Security right now. What it doesn’t mean is that the Social Security you pay is the Social Security you will receive later. The problem is that there are more individuals currently receiving benefits than there are individuals paying Social Security taxes and this is creating a shortfall. Congress anticipated this would happen so a few decades back they actually instituted some measures to create an extra cushion of funding. When you hear people talk about Social Security running out, what they’re referring to is that cushion which is expected to be depleted in the next 10 to 20 years. What it doesn’t mean is that Social Security will go away completely. Working individuals will continue to pay Social Security taxes, thereby funding the program. There just aren’t enough of them. There are several ways to solve this problem. One option, which seems pretty likely is that we will see policymakers continue to raise the full retirement age for future recipients.


Full Retirement Age

- Full retirement age is the age at which you receive your full benefit.

- Currently it’s between 66 and 67 years of age depending on when you were born

- You can take your benefit early (currently as early as 62) but it will be reduced for every year you take it early.

- Conversely, waiting will increase your benefit by 8% for each year you wait up until age 70.

- The breakeven is somewhere in your late 70s.

- If you are in good health and have a history of longevity in your family, waiting to take the benefit could result in a larger overall benefit to you over time.


Another solution to the shortfall is a reduction or elimination of benefits. This is unlikely for one major reason – recipients are also voters. If anything, reducing or eliminating benefits will be a problem for younger generations but is unlikely to affect current recipients or those who will receive benefits in the near future.


[1] “Social Security.” Social Security History. Accessed November 5, 2019. https://www.ssa.gov/history/briefhistory3.html.

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