Social Security Basics

Social Security was established more than 85 years ago during the Great Depression and continues today as a main retirement vehicle for many Americans. Although best known for its retirement benefits, Social Security also provides life and disability insurance, and processes applications for Medicare.

Employees who’ve worked and paid into Social Security through payroll deductions are eligible for these benefits, which can also extend to your spouse and children in certain situations.

President Franklin Roosevelt signed the Social Security Act on August 14, 1935. Although the program has changed since then, it continues to be a major source of income for people over age 65 and older. For instance, 9 out of 10 people aged 65 and older were receiving Social Security benefits in June 2023.

How it Works

Social Security is financed through payroll taxes set by law that both you and your employer contribute to. You’ll pay 6.2% of wages towards retirement and disability benefits, and 1.45% toward Medicare coverage, and your employer contributes the same amounts. If you’re self-employed, you’ll pay 12.4% towards retirement and disability.

Because contributions are calculated as a percentage instead of a flat amount, the more you earn, the more you’ll pay. There is a cap on retirement and disability contributions, though—in 2024, the taxable maximum is $168,600. You won’t pay Social Security payroll taxes on wages above that amount. There is no cap on Medicare contributions.

Where Your Dollars Go

According to the Social Security Administration (SSA), about 85 cents of every Social Security tax dollar paid goes into a trust fund that pays retirement benefits. About 15 cents goes to a trust fund that pays disability benefits. The costs of managing these programs comes from the trust funds, but equals less than 1 penny of every Social Security tax dollar you pay.

How You Benefit

Social Security benefits do not replace all of your earnings when you retire, qualify for disability protection, or die. Instead, you’ll get a payment based on how much you earned during your working years. If you earned more over your career lifetime, you’ll earn higher benefits. To receive full benefits for your situation, you need to earn 40 Social Security “credits” over a lifetime. You can earn up to four credits a year, and each credit represents a certain amount of earnings. For instance, in 2024, one credit equals $1,730 in earnings. If you earn four credits a year, you’ll need to work for 10 or more years collectively to receive full Social Security benefits.

Your benefits are calculated with the following in mind:

• First, the SSA determines your lifetime earnings.
• This number is adjusted for inflation using special calculations that account for your 35 highest earning years.
• Next, the total adjusted earnings are divided by the months you worked in those 35 years. The result is your average indexed monthly earnings, or AIME.
• Your permanent base benefits are based on your AIME.

When You Start

You can start receiving Social Security benefits as early as age 62, but your benefits will increase if you delay receiving them until they cap at age 70. If you start at 62, you won’t receive the full amount—in fact, it could be up to 30% less in benefits.

Even though you automatically contribute to Social Security taxes, you’ll need to apply to the SSA to receive benefits. Start looking into qualifications and estimated payments at least a year ahead of when you plan to retire, to see how your start date impacts your overall benefits.

Taxes on Benefits

What you receive from Social Security benefits is not necessarily what you’ll keep. You may owe taxes on part of your benefits—but this usually applies to people who have substantial income in addition to their Social Security payments. Based on IRS rules, you’ll likely pay taxes on up to 85% of your Social Security benefits if you:

• are married and file a separate tax return.
• file a federal tax return as an individual and your combined income from all sources is more than $34,000. If it’s between $25,000 and $34,000, you may have to pay income tax on up to 50% of benefits.
• file a joint tax return and you and your spouse have a combined income from all sources of more than $44,000. If your income is between $32,000 and $44,000, you may owe tax on up to 50% of your benefits.

Future Changes

Social Security has changed over the years, and more changes are likely on the horizon. Approximately 67 million Americans a month receive Social Security benefits, totaling $1.4 trillion in paid benefits every year, and that number is expected to only get bigger. The life expectancy for Americans ages 65 and older has increased from 14 years in 1940 to more than 20 years today. And the number of Americans 65 and older is estimated to increase from 58 million in 2022 to 75 million in 2035.

This influx of retirees raises questions about how long Social Security trust funds will last. In 1950, there were 16 workers for every retired person. In 2023, there are 2.7 workers contributing to Social Security for every retiree. By 2035, estimates predict 2.3 covered workers for each retiree. The SSA expects benefits to be fully payable until 2037, when trust fund reserves are predicted to be exhausted. Once this happens, payroll taxes will still fund a percentage of benefits, even as much as 80% of expected benefits. There are other solutions that can help extend these funds or raise that amount, too, like Congress raising the Social Security payroll tax rate for all workers, raising the full retirement age, and other solutions.