SOCIAL SECURITY BENEFITS BRIEF OUTLINE

 The world of the Social Security Administration is very complex, just like the IRS.  This is a very brief outline of some information regarding benefits and should not be used as a basis for any retirement decision.  Specific information should be obtained directly from social security on any issues since only their decision counts.  Additional information can be obtained directly from them and on their website, www.ssa.gov.  You can even calculate your own retirement benefit from the Internet program, ANYPIA, as long as you have all of your earnings information at hand.

REQUIRED CREDITS (formerly know as “quarters of coverage”) 

A person must have 40 “credits” to qualify for any retirement benefits at retirement age.  These 40 “credits” have nothing to do with the level of the benefit you will receive, they are just the minimum qualifying credits needed to be eligible for any social security benefits.  This basically equates to 10 years of four quarters per year.  Each “credit” is based upon on a calendar quarter of earning the minimum amount of wages as established by the Social Security Administration.  Remember, only earnings from wages and self-employment count, not investment or rental income, or any source income on which social security taxes have not been imposed such as limited partnerships, S corporation dividends, etc.  If you have only 40 “credits,” you will not qualify for the maximum benefit, as you will quickly see below.

WHAT ARE SOCIAL SECURITY BENEFITS BASED UPON? 

Benefits are NOT based on the last five years of a person’s employment.  Benefit payments are based upon a person’s earnings averaged over 35 years of his/her working lifetime.  The calculation takes into account the HIGHEST 35 years of earnings and is based upon the average of those 35 years.  The actual earnings in each year are “indexed” (adjusted) to account for changes in average wages since the year the wages were earned, basically an inflation adjustment.  For instance, the $3,600 maximum social security earnings in 1951 has an “index factor” of 9.80, which means the earnings will be credited as if you had earned $35,280 for that year.  So, the computation is made by adding together your 35 highest years of “indexed” earnings and dividing that total by 35.  If you have only 30 years of earnings, you calculate the total indexed earnings for those 30 years, and still divide that figure by 35, which is why those with less than 35 years of covered earnings cannot receive the maximum benefit.  This calculation determines your Average Indexed Monthly earnings (AIME).  Social Security then applies a formula to the AIME figure to arrive at your basic benefit or “primary insurance amount” or  “PIA.”  This formula is involves adding the total of multiplying the first $505 of AIME by 90%, the next $2,538 of AIME by 32%, and any AIME above $2,538 by 15%.  Leave it to the government to make a simple calculation unbelievably complex.

WILL YOU BE PENALIZED FOR EARLY RETIREMENT? 

Possibly.  By retiring early, you will have less opportunity to replace years of lower earnings with higher earnings.  This could reduce the amount of your monthly benefit.  Also see Receiving Benefits Before Age 65 below.

FACTORS INCREASING OR REDUCING YOUR RETIREMENT BENEFIT. 

Receiving Benefits Before Age 65.  You can receive benefits at age 62, but at a reduced rate.  Your benefit is reduced by 5/9ths of one percent for each month you collect benefits before age 65.  This equates to a reduction approximately 20% at age 62.  The closer you are to age 65, the smaller the reduction.  The age to receive the maximum will increase up to 67 in the year, and the reduction at age 62 will increase.  

Delaying Retirement Past Age 65.  You may delay collecting benefits until after age 65.  Your benefit will be increased by a certain percent each month that you are past 65 until you reach age 70, and are not receiving benefits.  These increases in the benefit amount are automatically added to the monthly benefit amount you will receive.   

Having Earnings After Benefits Begin.  If you have earnings after you begin collecting benefits, and these earnings exceed those credited to you during one of your 35 years used in calculating your basic benefit, you are eligible to receive an increased monthly benefit.  Caution, there are earnings limits if you are under age 65 which might required that you repay benefits received if your income exceeds a certain level. 

WILL AGE 65 CONTINUE TO BE THE RETIREMENT AGE TO RECEIVE FULL BENEFITS?

No.  The minimum retirement age to collect full benefits is schedule to begin rising over the next few years, up to 66 by the year 2005.  The age 62 early retirement option will remain unchanged, but the increased retirement age will result in a larger reduction for early retirement since there will be more months between the normal retirement age and age 62. 

WHAT IF I WILL RECEIVE BENEFITS FROM A PENSION FROM WORK NOT COVERED UNDER SOCIAL SECURITY, SUCH AS PERA? 

Typically, is you receive benefits from such a source, social security benefits will be reduced or possibly eliminated altogether, depending on the amount of the pension received and whether it is received as a primary beneficiary or as a surviving spouse.  The pension amount is not affected, only the social security benefits may be reduced.  The rules in this area are quite complex, so just be aware of this rule and do further research if it will affect you.

OTHER BENEFITS AVAILABLE

WHAT IF I HAVE EARNINGS WHILE COLLECTING SOCIAL SECURITY BENEFITS?  

If you have income from wages or self-employment while collecting social security benefits, you may have to return a portion or all of your benefits depending on the amount of earnings.  Earnings for this purpose DOES NOT include income from investments such as interest and dividends, rental income, pension plan distributions, or income from the sale of assets including a home. 

If you are age 62 through 64, you can have earned income up to $11,640 (for 2004) and retain all of your social security benefits.  If you have earned income in excess of $11,640 during the year, you will have to repay social security benefits received in an amount equal to $1 for every $2 earned in excess of $11,640.  So, if you had earned income $13,640 during 2004, you would have to repay $1,000 to social security.  The maximum amount is increased annually due to inflation.  There is a special rule for earnings during the year an individual reaches age 65.  Generally, an individual can earn $30,000 during the calendar year in which they attain age 65 with no reduction in benefits.   Earnings above that level result in an amount equal to to $1 for every $3 in excess of $30,000 will need to be repaid to social security.

Once you reach age 65, earn all you can.  There are no earned income limitations for the over 65 crowd.  Finally, a benefit, but look out for the greedy IRS as you will see below. 

ARE YOUR SOCIAL SECURITY BENEFITS INCOME TAX FREE? 

Yes, rarely, and no usually.  Up to 85% of a person’s of social security benefits can be subject to federal income tax.  If your only source of income is social security benefits, they are exempt from income tax.  However, if you have any other sources of income such as wages, pension plans, dividends, interest, gambling winnings, etc., some of the benefits may subject to federal income tax depending on the total of the level of income from the other sources when combined with the amount of social security benefits.  A general rule-of-thumb threshold is that if your other sources of income, exclusive of social security benefits, is $25,000 or less, your social security benefits are typically tax exempt.  The threshold of other sources of income rises to basically $32,000 for a married couple before social security benefits become taxable.  When married filing separately is claimed and the taxpayer lives in the same home as the spouse for 1 day or longer, 85% of the benefits received are automatically taxable.

Different states have different rules about the taxability of social security benefits.  Some states exempt some or all of the benefits, and some do not exempt any of the benefits from state tax.  In Colorado, each individual is entitled to exempt up to $20,000 each year, $24,000 if over age 65, of “retirement benefits” received from state tax.  Social security benefits are just one component of the retirement benefits category.  For example, if you are age 64 receive a pension or an IRA distribution of $18,000 and had federally taxable social security benefits of $5,000, only $2,000 of social security benefits would be exempt from Colorado state tax and the remaining $3,000 would be fully taxable, based upon the $20,000 annual maximum exclusion.  

WHEN SHOULD I START COLLECTING SOCIAL SECURITY BENEFITS.