Creating an effective income strategy is top priority for Americans working to secure a comfortable retirement. After all, the more accurately you can predict what's needed to cover expenses in old age, the more you can finetune
your savings habits during the accumulation years. Social Security (SS) benefits remain an essential piece of the retirement income pie. This source of lasting retiree income provides the basis for gauging overall income needs.
In this piece, we'll focus on ways to make the system work for you and your income goals. SS benefits can be fairly complex, so let's start with the basics.
Paying into the system
SS taxes, known as FICA or OASDI, are deducted from your pay during working years, and they cover retirement, disability, dependent and survivor benefits.1 In 2013, workers will pay 6.2% of their annual income (up to $113,700) in SS taxes and 1.45% of their total annual income in Medicare taxes.2 Employers make a 6.2% SS contribution plus a 1.45% Medicare contribution for their employees, while self-employed individuals shoulder the entire 15.3% contribution (12.4% in SS taxes and 2.9% in Medicare taxes). Starting in 2013, the Medicare tax rate rises to 2.35% for single taxpayers with an annual income of more than $200,000 and for married joint filers whose combined annual income exceeds $250,000. As you work, you earn credits — up to four per year that count toward benefit eligibility. To be eligible for SS retirement benefits, a worker born after 1928 must have accumulated at least 40 credits. To give you an idea of benefits accrued, the Social Security Administration (SSA) sends its annual four-page statement of estimated monthly benefits in today's dollars to all working people age 60 and older (if they are not already receiving benefits). All worke rs age 18 or older can apply to get a personalized online SS statement or can use the SSA's online Retirement Estimator. The closer you are to retirement, the closer these projections are to
|Rising Retirement Ages
|Year of Birth
||Full Retirement Age
||66 and 2 months
||66 and 4 months
||66 and 6 months
||66 and 8 months
||66 and 10 months
|1960 and later
Figuring retirement benefits
SS retirement benefits are based on wages earned throughout your working life. The more you earn during your career, the higher your benefits. Likewise, lowerearning years may result in a lower benefit payout. The SSA uses your highest 35 wage-earning years to calculate benefits. The age at which you decide to retire also affects the monthly benefit you receive. Full Retirement Age (FRA) is the age you become eligible to collect 100% of your SS retirement benefits. As shown here, FRA is determined by the year you were born, and it has been slowly rising to keep pace with the aging baby boomer population and increasing life expectancy.
Considering when to retire
You can choose to retire as early as age 62 and claim SS benefits, but your payments will be reduced for life. Currently, benefits are permanently reduced by about 25% if you retire early at age 62. Conversely, if you decide to delay retirement, your benefit amount will be higher than if you retired at FRA. That increase is based on the length of time from FRA until benefits begin, or until age 70, whichever comes first. The consequences of early or delayed retirement should be carefully considered.
|A Decade of COLAs1
Guarding against inflation
The cost-of-living adjustment (COLA) may be SS's greatest long-term planning benefit. It's designed to protect the purchasing power of your benefits. Each year, SS retirement benefits are adjusted according to the percentage increase in the US Consumer Price Index (CPI-W). If the index shows no increase, there is no COLA. These adjustments represent one of the best ways to hedge retirement income against inflation. The chart to the right shows when inflation prompted COLAs over the last 10 years.
Understanding benefit taxation
SS benefits are not necessarily tax-free. According to the SSA, about one-third of SS recipients pay income taxes on their benefits.2 Your combined income, which equals adjusted gross income plus non-taxable interest plus 50% of your SS benefits, determines how much of your benefits are taxable. In 2013, up to 85% of your benefits may be subject to taxation if your combined annual income is more than $34,000 for single filers and $44,000 for married couples filing jointly. In addition to that, combined income limits are not adjusted for inflation, so taxation of benefits affects more people every year. The SSA sends you an official form (SSA-1099) that has information about your benefits to use when completing your tax return.
Staying on top of Social Security
As you know, it takes knowledge and motivation to make the most of your retirement benefits. Let us help guide you — review the information provided here and in other articles in this series on Social Security to help you understand key factors that may impact your benefits and may provide ways to maximize spousal and survivor benefits. Also, check out the helpful resources and tools offered on ssa.gov. As always, work closely with your tax and financial professionals as you head toward retirement.
Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. It was not intended or written to be used, and it cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed on the taxpayer under US federal tax laws. Federal and state tax laws are complex and change frequently.
You should always consult your own legal or tax professional for information concerning your individual situation. IRA owners are encouraged to seek the advice of an attorney or tax advisor who specializes in this area.
The opinions in this piece are not necessarily those of Invesco. Information in this report does not pertain to any Invesco product and is not a solicitation for any product.