Demystifying Social Security

Social Security benefits form a bedrock of retirement income for tens of millions of Americans. And yet, many would agree that the program is mired with unnecessary complexity which makes claiming benefits confusing.  My intent is to use this blog post to help demystify some of the confusing elements of the Social Security retirement benefit.

First, a bit of background and historical context. The Old Age, Survivors, and Disability Insurance (OASDI) program, better known as Social Security, was enacted by Congress in 1935 to help Americans suffering in the wake of the Great Depression. Originally intended as a retirement income program, Social Security expanded over time to include disability benefits and family/survivor benefits in the event of premature death.  Social Security is designed as a pay-as-you-go program which means that the benefits of current retirees are funded by the current contributions of today’s workforce through FICA and self-employment taxes.  As long as an individual accrues 40 credits (done over 10 years in most cases) of eligible employment, they have an entitlement to Social Security income (SSI) benefits.

To determine an individual’s benefit entitlement, the highest 35 years of earnings are averaged (and adjusted for inflation) to arrive at the primary insurance amount (PIA). The PIA is the benefit an individual will receive at their normal retirement age (i.e., 66 or 67, depending on your year of birth). An individual can elect to begin Social Security benefits as early as age 62 or as late as age 70.  The PIA is adjusted up or down depending on when benefits commence.  For individuals or couples with sufficient assets or other pensions, it is often advantageous to delay drawing on Social Security until age 70 because for each year you wait, the benefit increases by approximately 8%.  This is essentially an 8% return backed by the US government.  A strategy involving delaying the onset of Social Security will likely necessity earlier distributions from other retirement assets, but with proper planning, this can be easily managed.

Even if you never worked outside the home, if you are married you may still have an entitlement to a spousal benefit. If both spouses have their own work history, the lower-earning spouse has the option to claim based on his/her own earnings history or take the spousal benefit from the partner, if higher.  However, the timing of making a claim can impact the total benefit payment and the amount of the benefit subject to tax.  In 2018, if a married couple has more than $44,000 in provisional income[1], they will pay tax on 85% of their SSI benefit.  Moreover, if you or your spouse have earnings from a pension a job that wasn’t covered by Social Security (e.g., a state pension from work abroad), you may be affected by the Windfall Elimination Provision (WEP) or the Government Pension Offset (GPO).  These are more nuanced topics that may require the assistance of your accountant.

A key challenge facing Social Security is an aging population. Americans are living longer, meaning they will be drawing on their benefits for a greater number of years.  At age 65, the average man can expect to live another 19 years, while the average woman can expect to live another 22 years[2]. Despite this fact and the incentive of an increased benefit associated with deferring to claim until a later age, approximately 40% of retirees claim their benefit at age 62 or shortly thereafter, resulting in a permanently reduced benefit[3].  We have a tendency to underestimate our life expectancy, but a real crisis could emerge if you outlive your life expectancy and prematurely deplete your assets.  If you begin drawing at 62, the benefit can be reduced by as much as 25% from your PIA or full-retirement benefit.  This is significant for a few reasons:

  1. If your spouse is claiming a benefit based on your benefit (as opposed to his or her own work history), the spousal benefit will also be reduced.
  2. You will have to supplement to a larger degree with other assets to fill the gap in your retirement income, likely resulting in greater depletion of your total wealth over time
  3. If you are still working at age 62, you may be subject to a further benefit reduction due if you breach the annual earnings limit (currently approx. $17,000 in 2018).
  4. Taxes can be imposed on as much as 85% of your Social Security benefit resulting in the need to further subsidize with other assets.

The decision of when to start Social Security requires a thorough break-even analysis of one’s retirement cash flow, including a consideration for longevity, taxes, inflation, and an assumed rate of return on investment assets. If an individual lives into her mid-80s, she is generally better off delaying the commencement of benefits. The above factors considered, there are often strong reasons to elect to claim early benefits, especially if cash flow is a concern immediately upon retiring.  Some argue that Social Security’s solvency or legislative changes could affect future benefits.  This is a valid concern but given how many Americans are reliant upon Social Security income, it is unlikely to see the program materially depleted as it would be very unpopular politically.  It is probable that we will see a restructuring of benefit calculations in order to deal with the growing population of retirees.

To learn more about SSI, visit or talk directly with your financial advisor.



[2] “Calculators: Life Expectancy,” Social Security (2017),

[3] “Social Security in the New Retirement,” Financial Engines, January 2016.

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