Why is Social Security Important?

Social Security has been a hot topic in the news recently, with often conflicting headlines about misappropriated payments, benefit cuts, and even the program’s possible bankruptcy. I’ll share my thoughts on those concerns in a future piece, but first, let’s take a look at how Social Security started and how it works.

How Did Social Security Begin?

Social Security was created after the Great Depression, when roughly 1 in 4 Americans were unemployed, and many seniors faced extreme poverty. To address this, President Franklin D. Roosevelt signed the Social Security Act in 1935 as part of the New Deal. Since the first payments were made in 1940, Social Security has played an important role in retirement planning for millions of Americans.

Fun fact: the first social security check ever issued was to Ida May Fuller of Vermont in 1940. She only paid $24.75 into the system but collected over $23,000 in lifetime benefits because she lived to be 100 years old!

Here is Ida with her check

How Does Social Security Work?

The mechanics of how Social Security payments actually work are often misunderstood. In simple terms, it’s funded through payroll taxes:

• Employees contribute 6.2% of their wages.
• Employers match this with another 6.2% (for a total of 12.4%).
• Self-employed individuals pay the full 12.4%, but they can deduct half as a business expense.
• These taxes only apply to earnings up to $168,600 (as of 2024). Income above this limit is not taxed for Social Security.

The money collected goes into two separate trust funds:

• Old-Age and Survivors Insurance (OASI): This pays benefits to retired workers and survivors — what most people think of as Social Security.
• Disability Insurance (DI): This pays benefits to disabled workers.

Social Security operates on a “pay-as-you-go” system, meaning today’s workers fund benefits for current retirees.

While no one likes paying taxes, Social Security is a vital safety net for many seniors. This Simpsons clip perfectly encapsulates the different attitudes of young people paying into the system versus older people receiving their benefits. The Simpsons – FICA Social Security Tax.

How Are Social Security Benefits Calculated?

Social Security is designed to replace a higher percentage of income for lower earners:

• Workers earning less than $30,000 per year may have up to 60% of their income replaced in retirement.
• High earners making closer to $168,000 may receive only 25-30% of their previous income in benefits.
• This structure aims to ensure financial support for lower-income retirees.

What About Spousal and Survivor Benefits?

Social Security isn’t only for retirees! It also provides benefits for spouses and survivors:

• Spousal Benefits: When you reach retirement age, you can claim up to 50% of your spouse’s benefit if it’s higher than your own.
• Survivor Benefits: Widows and widowers can receive benefits based on their late spouse’s work history.
• Divorced Spouses: If you were married for at least 10 years, you may qualify for benefits based on your ex-spouse’s earnings.

Is Social Security Taxed?

Unfortunately, yes! Many people are surprised to learn that Social Security benefits can be taxed. The amount depends on your total income:

• For single filers, benefits are taxed if income exceeds $25,000.
• For married filers, benefits are taxed if combined income exceeds $32,000.

This includes income from work, investments, or pensions. Up to 85% of benefits can be taxed. While there has been some talk of getting rid of the tax due on Social Security, this seems unlikely to me.

Key Social Security Facts

• You can claim benefits anytime between ages 62 and 70.
• If you were born in 1960 or later, your full retirement age is 67 — this is the age at which you can receive full benefits.
• Taking Social Security early reduces benefits by 6-7% per year, while delaying past 67 increases benefits by about 8% per year.

What’s Next?

Next time, I’ll dive into some of the challenges facing Social Security and explore potential solutions.

Is there a financial topic that you would like to learn more about? Feel free to let me know and maybe I will do a deep dive in the future.