Fundamentals of Social Security Benefits

Throughout history, many Americans have struggled to overcome poverty, but the elderly, disabled and those without support networks have often faced the greatest challenges. After the stock market crash in 1929, roughly half of older Americans had no reliable income and depended on charity and family to survive.

In 1935, recognizing the urgent need for financial security, the U.S. government, under Franklin Roosevelt, introduced a program, funded by payroll taxes, to give citizens a lifeline in hard times. As part of Roosevelt’s New Deal, this program was named Social Security.

What is Social Security?

Social Security is a government program that provides financial support to retirees, people with disabilities, and families of workers who have died. This program ensures that people who contributed to the system receive aid when they need it most. An individual’s benefit amount varies based on their earnings history, the age they start collecting, and whether they qualify for survivor benefits.

Although Social Security is not designed to be someone’s sole source of retirement income, it plays a key role in supplementing savings and pensions. Millions rely on it and understanding how it works is essential for financial planning and long-term security.  

Maximizing Your Retirement

Planning for a financially secure retirement is about more than just saving and investing; it’s about understanding how the pieces of your financial puzzle work together. Because Social Security protects you from outliving your assets by providing a guaranteed stream of lifetime income — adjusted annually to offset inflation — it is a valuable piece of that puzzle. The decisions you make about when and how to claim your benefits can significantly impact your financial security for decades to come.

First, Social Security retirement benefits are based on your 35-year earnings history. If you have years without income, continuing to work can replace those zeroes and increase your benefit amount. Because workers tend to earn more in later years, working longer can also replace earlier, lower-wage years, substantially increasing the 35-year average, and thus, increasing Social Security benefits.

On average, Social Security replaces only about 40% of an individual’s annual pre-retirement earnings. That’s why it’s essential to have a plan for supplementing your benefits with other sources of income, whether that’s a military retirement, pension, or income generated by retirement accounts and other investments.

Consider the following two scenarios to see the role Social Security can play in one’s retirement lifestyle:

David, 67, depends entirely on Social Security and a small, traditional IRA for his income. His monthly income covers rent, groceries and utilities, but leaves little room for emergency expenses or leisure. David avoids travel, entertainment, and dining out. He carefully budgets every dollar, but with rising healthcare costs, and limited ways to increase his income, he is constantly stressed about his financial situation.

Linda, 71, planned ahead. She supplements her Social Security with savings, an employer-sponsored 401k, and investments. She enjoys a comfortable retirement, travelling and dining without worry. Her additional income allows her to easily handle medical expenses and the rising cost of living. Linda has peace of mind, knowing she can handle financial emergencies without sacrificing her quality of life.

Which retirement scenario sounds more like the one you’d want? A secure retirement isn’t about luck – it’s about smart decisions, made early.

Timing Your Benefits

You are eligible to receive full Social Security benefits when you reach what is referred to as full retirement age (FRA), which is 66 or 67, depending on your birth year.

You can begin receiving benefits as early as age 62, but if you elect to do so, your monthly check will be reduced by 30%. On the other hand, your payment will be permanently increased for each month you wait to claim after reaching FRA, up to age 70. Let’s get a sense of what that looks like in dollar terms for someone who qualified for the maximum:

Age 62: $2,710

Age 66-67 (FRA): $3,822

Age 70: $4,873

As these numbers illustrate, deferring your benefits for even just a few years can make a big difference in the monthly amount you receive for the rest of your life. But that doesn’t necessarily mean that waiting until age 70 is the right choice for everybody.

If you need Social Security income to be able to retire, but don’t want to work until you’re 70, you’ll need to decide whether you can afford to live on less. If you have a history of health problems, personally or within your family, it may make sense to receive a smaller benefit for longer, rather than waiting to receive a larger benefit.

If you are in good health, and can retire without Social Security, or plan on working until later in life, waiting to claim your benefits is one of the surest ways you can lock in more guaranteed lifetime income.

Social Security and Other Retirement Income Sources

Social Security plays a critical role in complementing pensions, 401(k)s, IRAs, and other investments by providing a stable, inflation-adjusted income stream. Here's how it works in tandem with other savings vehicles:

Inflation Protection

Social Security benefits are automatically adjusted each year based on the Consumer Price Index, which helps to maintain purchasing power in retirement. Most pensions, 401(k)s, and IRAs do not offer automatic inflation adjustments, making Social Security a valuable tool for offsetting the risk that rising prices pose to your financial security in retirement.

Diversification of Income Sources

Relying solely on savings or investments like 401(k)s, IRAs, or pensions can expose you to market downturns or poor investment performance. Social Security diversifies your income sources by serving as a non-market-dependent stream of income. This diversification can reduce the overall risk in your retirement plan.

Tax Efficiency

Social Security benefits may be taxed at a lower rate than withdrawals from traditional 401(k)s or IRAs, depending on your overall income. For high-income retirees, Social Security can be a more tax-efficient source of income, especially when combined with Roth IRAs, which allow for tax-free withdrawals. This tax efficiency helps stretch retirement income.

Flexible Withdrawal Strategy

By coordinating Social Security benefits with withdrawals from pensions, 401(k)s, and IRAs, retirees can create a flexible income strategy. For example, delaying Social Security can increase the benefit amount, while tapping into other funds earlier can cover short-term needs. This allows retirees to optimize the timing of different income sources for maximum financial efficiency.

The Impact of Work on Social Security

Continuing to work while receiving Social Security benefits reduce your benefit, depending on your age and the amount you earn. Here’s a breakdown:

For Those Under Full Retirement Age (FRA)

• Earnings Limits: If you’re receiving Social Security benefits but have not reached FRA, there’s an annual earnings limit of $23,400 in 2025. If you exceed this limit, $1 in benefits will be withheld for every $2 earned above the threshold.
  • In the year you reach full retirement age, the reduction is $1 for every $3 earned above $62,160. If your earnings are high enough, your benefits could be temporarily reduced to zero, but they will be recalculated once you reach full retirement age.
  • Earnings limits are adjusted annually for inflation.
• Adjustment of Benefits: Once you reach your FRA, any withheld benefits are recalculated, which can increase your monthly benefits in the future.
• Tax Implications: Working while receiving benefits can also affect your tax situation. If your combined income exceeds certain thresholds, you may owe taxes on a higher percentage of your benefits.

After you reach your FRA, you can earn any amount without affecting your Social Security benefits.

Understanding Social Security Taxation

Your benefits may be taxable based on your overall income, also known as ‘‘combined income,’’ which includes:

• Adjusted Gross Income (AGI): This is your total income minus certain deductions.
• Non-taxable interest: Such as interest from municipal bonds.
• Half of your Social Security benefits: Used in determining taxation thresholds.
  

The thresholds for taxation are as follows:

• Individuals:
  • If your overall income is between $25,000 and $34,000, up to 50% of your benefits may be taxable.
  • Above $34,000, up to 85% may be taxable.
• Married couples filing jointly:
  • If your joint, overall income is $32,000 to $44,000, up to 50% of your benefits may be taxable.
  • Over $44,000, up to 85% may be taxable.

Strategies for Minimizing Taxes on Social Security Benefits

There are a few tried-and-true methods for reducing the tax burden on your Social Security benefits:

Consider a Roth Conversion

Withdrawals from Roth IRAs do not count toward combined income, unlike traditional IRA withdrawals. Converting assets from a traditional IRA to a Roth IRA can reduce future tax burdens, though taxes must be paid upfront.

Tax Loss Harvesting

If you have investments in taxable accounts, consider selling losing investments to offset gains, which can lower your AGI, and reduce taxable Social Security benefits.

Utilize Deductions and Credits

Maximize deductions such as medical expenses, which can reduce your AGI. Many retirees also relocate to optimize their financial situation. Currently, 41 states do not tax Social Security benefits at all.

Strategic Charitable Contributions

If you are charitably inclined, consider donating appreciated securities instead of cash. This can lower your taxable income without affecting your combined income calculations.

Using David and Linda as examples again, consider how strategic tax moves can make a difference in retirement income:

David, 67, never learned about the tax breaks he could qualify for, leaving him vulnerable to reductions on his Social Security benefits. Without a viable strategy, more of his income is subject to taxation, shrinking his already limited budget. He struggles to find ways to reduce his tax burden, making it even harder to cover rising expenses.

Linda, 71, identified ways to minimize the taxes on her Social Security. She strategically converted to a Roth IRA, sold losing investments to offset taxable gains, and used charitable giving to lower her taxable income. Her careful planning ensures she keeps more of her benefits, providing further stability and comfort in retirement.

Which retirement sounds better? Paying unnecessary taxes or keeping more of your benefits? Wise planning makes all the difference. Taking the time to manage Social Security taxes can mean the difference between financial stress and peace of mind in retirement.

Talk to Your Financial Advisor

Your advisor can work with you to tailor strategies to your specific situation, ensuring you optimize your income sources and minimize tax liabilities effectively.

Frequently Asked Questions About Social Security

Who is eligible for Social Security benefits?

Most workers who have paid into Social Security for at least 10 years are eligible for retirement benefits. You can check your eligibility here.

How much should I rely on Social Security benefits?

Social Security can provide a financial foundation to cover basic needs, but it was never meant to be a sole source of retirement income. A strong retirement plan should include savings, investments, and other sources of income.

How much longer will Social Security last?

The longevity and reliability of Social Security is an evolving situation. Without congressional action, the Social Security Trust Fund is projected to run out of money by 2033. If this occurs, retirees are projected to receive 83% of their full benefits.  

Can my spouse collect some of my Social Security?

Social Security benefits allow a qualified spouse to choose between collecting an amount based on their own earnings, or half of their spouse’s benefit, depending on which is higher. For a spouse with a limited or low earnings history, this option can substantially increase their benefits.

Key points about spousal Social Security benefits: 

• Marriage duration: You must be married for at least one year to be eligible for spousal benefits. 
• Age requirement: You must be at least 62 years old to claim spousal benefits but must reach full retirement age (FRA) to qualify for the maximum 50% of your spouse’s benefit. 
• Spousal benefits: Your spouse must be receiving Social Security benefits for you to claim spousal benefits on their record.
• No advantage to waiting: You won’t receive increased benefits by waiting past your full retirement age (FRA) before you start collecting spousal benefits.
• Survivor benefits: If your spouse passes away, you may be eligible for up to 100% of their benefit, depending on your age and circumstances. Claiming before full retirement age may reduce your benefit, while waiting until full retirement age ensures you receive the maximum survivor benefit. However, delaying past full retirement age does not earn additional credits, so there is no advantage in waiting beyond that point to claim survivor benefits.

First Command does not provide legal or tax advice, and this article does not contain any legal or tax advice. Should you require legal or tax advice specific to your situation, you should consult with an attorney or qualified tax advisor. The information provided to you herein is provided for informational purposes only, is not intended to be tax or legal advice, and should not be used for the purpose of avoiding tax-related penalties under the Internal Revenue Code.

Diversification, asset allocation and portfolio rebalancing do not guarantee a profit or protect against a loss in a declining market. They are methods used to help manage risk. Investment returns and principal value will fluctuate and your investment, when redeemed, may be worth more or less than its original cost. Sales charges and taxes may apply.