In 1935 Franklin Roosevelt signed the Social Security Act.
The purpose of this New Deal program, then and now, is to ease the crisis of poverty in old age. Before Social Security, about half of senior citizens of lived (and died) in poverty. Today, that number has fallen to 10%, a decline widely attributed to the program's successes.
With more than $1 trillion in payments every year, Social Security makes up about a third of all elderly income in America. While analysis varies, anywhere from 12% to 44% of retirees depend on this program for almost all of their income.
The numbers don't lie. For both current retirees and workers planning for their future understanding how Social Security works is crucial. Not only does it play a key role in modern retirement planning, but if you've ever held a job then you've already paid for it. So here's how to get the most out of it.
Please note: Income cutoffs and qualifying ages for Social Security are subject to annual updates. Unless otherwise specified, all numbers are accurate for 2020 but subject to change.
What Is The Maximum Social Security Benefit?
For someone retiring in 2020 at full retirement age (66 or 67 years old for most modern retirees depending on the year of birth), the maximum Social Security benefit is $3,011 per month.
However, actual income is a function of what age you retire. Workers can begin collecting Social Security benefits as early as 62 years old, but the later you wait the more you collect. The major break points are:
- Early Retirement at 62, monthly benefits: $2,265
- Full Retirement at 66, monthly benefits: $3,011
- Delayed Retirement at 70, monthly benefits: $3,790.
Workers who delay retirement can increase their Social Security benefits up until age 70. As a result, the absolute maximum someone can get in 2020 will be $3,790 per month.
How the SSA Calculates Benefits
For an in-depth look at how the government reaches these numbers, see our article on How Social Security Is Calculated. The quick-and-dirty, however, is that the program is based on AIME, or "Average Indexed Monthly Earnings."
To calculate this, the government takes the highest-earning 35 years of your working life, caps them at the maximum taxable income for FICA taxes ($137,700 in 2020) and averages them together to create a representative annual income. It divides by 12 to get a monthly income, which is the AIME.
The government then runs your AIME through a three-tiered formula to calculate your Primary Insurance Amount (PIA). The formula always uses the same percentages, but the specific cutoffs (called "bend points") change from year to year. At time of writing the PIA formula is:
- 90% of AIME up to the first $960,
- 32% of AIME greater than $960, less than $5,785, and
- 15% of AIME greater than $5,785.
So if you earned $60,000 per year for your entire life and turned 62 in 2020, you would have an AIME of $5,000. The Social Security Administration (SSA) would calculate your benefits as follows:
- 90% of AIME up to the first $960: 0.9 x 895 = 864
- 32% of AIME between $960 and $5,785: .32 x 4,040 = 1,292.80
- 15% of AIME greater than $5,785: .15 x 0 = 0
- You would collect $2,156.80 per month in benefits.
The final result is then adjusted based on COLA, "Costs of Living Adjustment." This is the figure which the SSA uses to keep recipients' benefits current with inflation. It's also the figure which the SSA uses to adjust your benefits based on retirement age.
As a result of this system the less you earn over your working life the lower your Social Security benefits will be. Critics have pointed out that this ensures that people who have earned the least, and so most likely have little in retirement savings and pensions, also receive the least Social Security protection. Meanwhile, those most likely to already have robust 401(k)s take the lion's share of the program.
How to Get the Maximum Benefit
Those are the nuts and bolts of how Social Security works, so on to the next most important issue: There's a big difference between $3,011 and $3,790. How can you collect the absolute maximum amount in Social Security benefits?
Consider these approaches:
Once you begin collecting checks, your Social Security payments are set in stone. As a result, workers who retire at 62 permanently reduce their lifetime benefits.
So the first thing to do, if at all possible, is to delay retirement until age 70. For the four-year difference between standard retirement age and delayed retirement you will increase your total benefits by nearly 25%.
Note that in this case "retirement" doesn't actually mean when you stop working. In the language of Social Security, retirement simply means when you begin to claim your benefits. You can leave the office at age 66 or at 40 and still defer benefits until your 70th birthday.
Every year you wait after full retirement age raises your maximum benefits by nearly 8%. Even delaying by just 12 months will make a noticeable difference in the size of your monthly checks.
Now, this isn't always an option for every worker. Perhaps you have a physically demanding job, perhaps you need the money. Perhaps you and your partner are ready to run off toward the horizon together and aren't willing to wait another four years. There are many reasons to start collecting benefits earlier. But if you can do it, there's nearly $1,000 worth of reasons to wait.
We will not elaborate on this because it is self-evident. However, up until an income reaches $137,700, every dollar of additional income increases your Social Security earnings.
This is also another argument for delaying retirement. Your later years are likely to be your best-paying. For anyone with a work history more than 35 years long, the SSA takes your highest earning years and drops the rest. So adding a few years at the height of your career might eliminate those years you spent washing cars post-graduation.
This is a critical issue for people who have less than 35 years of work history. The SSA averages out of 35 no matter what, so if you haven't worked that long (for example, say you were a stay-at-home parent) they will factor in "$0.00" for the missing years.
Understand the Earnings Limit
Earning income while retired can change your Social Security benefits.
- It can reduce your benefits if you are younger than the full retirement age.
For young retirees, earning income above the yearly earnings limit reduces your Social Security benefits for that year. For workers who are younger than full retirement age, in 2020 the earnings limit will be $18,240. The SSA will reduce your benefits by $1 for every $2 you earn above that cap.
In the year at which you reach full retirement age these numbers go up. For 2020, the yearly earnings limit for someone in the year of their retirement is $48,600 and the SSA reduces benefits by $1 for every $3 you earn above the limit.
Once you reach full retirement age you can earn any amount of money without reducing your benefits.
- It can increase your benefits if you raise your lifetime income.
If you continue to work after full retirement age, even while collecting benefits, you can raise your Social Security benefits if you increase your net lifetime earnings. For retirees who continue to work, the SSA recalculates your AIME as new data comes in. If your post-retirement earnings increase your AIME, the SSA will adjust your benefits upward to reflect this.
This can happen if, while retired, you earn enough to replace one or more of the existing 35 years used to calculate your AIME. In our example above, our worker earned $60,000 per year steadily for his whole working life. If he kept working after retirement, but got a pay raise to $65,000, his AIME would go up each year he worked. His benefits would be adjusted to match.
This isn't a reason to take benefits early. But if you want to continue working while collecting Social Security it is, in fact, possible to raise your total benefits.
Coordinate With Your Spouse
If your spouse earned more than you did while working, spousal benefits may be a good way to boost your own Social Security income.
The SSA allows spouses to claim Social Security payments worth up to half of their partner's benefit amount. This is a potentially very good option for situations where one spouse earned significantly more than the other, or where one spouse worked and the other did not. Further, when one member of a married couple dies, the survivor is entitled to the deceased spouse's full benefit payment.
However, this will not stack with any existing benefits. If you have Social Security payments of your own, the SSA will issue a joint award equal to the higher of your eligible benefits.
Readers should also note that "File and Suspend" is no longer a viable option. This was a common strategy for married retirees, and as such appears in many advice columns on the subject.
File and suspend was when a spouse would reach full retirement age and file for retirement but suspend the payments. Filing for retirement would make his spouse eligible for spousal benefits. She would file for retirement but take spousal benefits rather than her own. Since neither were collecting their primary benefits, those would continue to accrue value until both retirees hit age 70, at which point they would begin to collect their larger primary benefits.
Congress closed this loophole in 2015.