Social Security: How It Works and How to Make Smarter Claiming Decisions
Social Security is an important, and often essential, part of a retirement plan. Originally created as “Old-Age Insurance” during the Great Depression to help prevent widespread poverty among retirees, the program has since evolved into what we now know as Social Security (Old-Age, Survivors, and Disability Insurance).
Not only does Social Security provide supplemental income in retirement, it also offers financial protection for retirees, spouses, and families. Funded largely (about 90%) by payroll taxes paid by both workers and employers, the program plays a significant role in long-term financial security.
Below, we’ll cover the basics of how Social Security works and how to thoughtfully approach your claiming strategy.
Who Can Receive Social Security Benefits?
- Retirees: You need about 10 years of work to qualify for your own retirement benefits. Part-time work counts, and once you earn the required credits, they never expire.
- Spouses: A spouse may be eligible for up to 50% of the worker’s benefit at Full Retirement Age (FRA).
- Divorced spouses: If a marriage lasted at least 10 years, a divorced spouse may also qualify, even if the worker has remarried.
- Survivors: Widows, widowers, and children may receive survivor benefits, often between 70% and 100% of the worker’s benefit. There is also a small one-time death benefit.
- Workers who become disabled: If you have earned Social Security credits and meet Social Security’s definition of disability, you may receive monthly benefits for up to a year.
How Is Your Benefit Determined?
In short, it depends on how long you worked and how much you earned.
The Social Security Administration looks at your 35 highest-earning years, adjusts those earnings for inflation, and averages them. That average is used to calculate your benefit at your Full Retirement Age (FRA). For anyone born in 1960 or later, FRA is 67.
Generally, the longer you work and the more money you earn, the higher your benefit will be.
That leads us to the big question…
When Should You Claim Social Security Retirement Benefits?
The amount you receive depends on the exact month you claim relative to your Full Retirement Age:
- Age 62 (early): Claiming as soon as you’re eligible at age 62 permanently reduces your benefit by as much as 30%. It’s also important to note that if you claim before FRA and continue working, your benefits may be temporarily reduced if your earnings exceed certain limits (though they are not permanently lost).
- FRA: Claiming at Full Retirement Age gives you your full benefit. Beginning at FRA, your benefits are no longer reduced due to earned income.
- Age 70 (delayed): Waiting beyond FRA increases your benefit by about 8% per year until age 70. After age 70, there is no additional advantage to waiting.
Bottom line: Claiming earlier means smaller checks for life, while waiting means fewer, but larger payments.
There is a balancing strategy for every individual, based on factors such as longevity, investments, outside income sources (pensions, annuities, etc.), and market performance. Because some of these variables are uncertain, there is no universal “right” answer. Below are two of the primary factors we consider when helping clients determine their optimal timing strategy.
- Full Financial Picture:
- If your expenses aren’t fully covered by Social Security or another income source, the remainder must come from your investments. Claiming early can reduce withdrawals in the early years, but the smaller benefit can place more pressure on your portfolio later in retirement. On the other hand, if cash flow allows, delaying benefits may help preserve investments over time, even though it requires using more of the portfolio in the early years.
- Sequence of Returns Risk:
- Also known as market timing risk, this occurs when a significant market downturn happens early in retirement, just as withdrawals begin. This can have a lasting impact on a portfolio. In cases like these, starting Social Security earlier may help reduce strain on investments during a market downturn.
Taxation
Social Security benefits may be subject to federal income tax, depending on your total income. Most states do not tax Social Security benefits (including Missouri and Kansas as of 2024).
If you have other sources of income, such as wages, retirement account withdrawals, or investment income, up to 85% of your Social Security benefit may be subject to federal income tax. Because of this, claiming decisions should be coordinated with your broader tax strategy.
How to Get Started
Whether retirement is approaching or still years away, proactive planning can make a meaningful difference.
- Create an account at SSA.gov: Review your earnings history and view your estimated benefits (at any age).
- Use a Social Security calculator: Many free tools offered online can help you compare early versus delayed claiming options.
- Talk with a Certified Financial Planner™ professional: Social Security affects taxes, investments, and long-term income planning. A qualified advisor can help you coordinate all the moving pieces.
If you have questions about your personal Social Security strategy, contact us. We are here to help you navigate the nuances of Social Security and tailor a strategy to your individual circumstances and goals.
