Social Security: How It Works and Strategies to Maximize Your Benefits

Retirement planning often includes Social Security benefits in the equation, so it’s important to understand the purpose of Social Security and how it works. Why? Because you’ll need to decide when to start taking Social Security benefits and coordinate that income with withdrawals from your various tax-advantaged retirement accounts.

Here’s what you need to know about one of our most popular safety net programs.

What Is Social Security?

Social Security is a safety net program designed to help retirees avoid poverty. But it was designed to be an income supplement, not to fully meet your income needs in retirement. The original idea was to create a program where workers can pay into the system now and receive benefits down the road, in proportion to what they contributed.

Social Security benefits alone are unlikely to provide enough money for you to live comfortably; for most people, personal retirement accounts that have grown over time are essential.

How Does Social Security Work?

At its core, Social Security is a “generational contract.” It’s not a traditional savings plan in which you set aside money and it grows over time. Instead, you pay Social Security taxes that are used to support current retirees. When it’s time for you to retire, future workers will theoretically be paying their taxes to support you. This tax is withheld from each paycheck, just like federal income taxes. You’ll see this Social Security tax deduction on your pay stub, although it may be called OASDI, FICA, or something else, depending upon your company’s payroll system. Even self-employed folks including freelancers and those with side gigs pay into Social Security, although they send it in as part of their federal taxes.

Currently, the Social Security retirement tax is 12.4% of your income. However, you only pay half the amount—6.2%—while your employer picks up the tab for the other half. Later, you’ll receive retirement benefits based on your age and how much you paid into the system. In theory, the more you pay into the system, the bigger your benefits payout will be.

However, your payout will also depend on when you start drawing retirement benefits. It’s true that you can start receiving benefits when you turn 62, but the amount you receive each month will be smaller because you didn’t wait until you reached your full retirement age (FRA). If you want to receive more each month, you need to wait until your FRA or longer. Your FRA is based on when you were born; see the Social Security Administration chart to determine your FRA (between 65 and 67).

If you want the largest possible monthly payment, waiting until you’re 70 to start drawing benefits is the way to go. 

How to Maximize Your Social Security Benefits

As you learn about Social Security, it’s important to understand how to maximize your benefits. There can be good reasons to start taking benefits before your FRA. Maybe you need the extra income because you retired early, or perhaps you had to stop working because of a health issue or a family situation. If you have a serious health condition and don’t expect to live into your later 70s, it can certainly make sense to claim early. Or if you have a pension or annuity payment for life that covers most of your expenses, a smaller monthly Social Security retirement payment could work well for you.

If you can delay taking Social Security, and you expect to live beyond age 78, it can make sense to put off taking your benefits and instead rely on your own retirement accounts and other assets. (More about long-life planning below.) Not only does Social Security pay you and your spouse for your entire life, but once you start receiving payments, your payment is indexed for inflation each year, meaning your benefit is increased to cover rising prices. This indexing or increase probably will not cover the full cost of rising prices, but it does help.

Another consideration is the spousal benefit. If your spouse has a much higher income than you do, it may make sense to claim your own lower benefit first, while your spouse delays claiming benefits based on their work history. In this way you’ll start getting a Social Security payment while your spouse’s benefit continues to grow. Once your spouse reaches age 70 (or at least their FRA), then your spouse claims their own Social Security benefit and you claim spousal benefits (if the spousal benefits are in fact larger than your personal benefits). To put it simply, draw your own benefits until it makes sense to claim the spousal benefit, but remember that you can’t claim a spousal benefit until your partner files for their Social Security benefits.

Don’t forget to consider whether you want to work while taking Social Security benefits. Depending on your income, a portion of your Social Security benefits might be taxable. That can change the timing equation, and may help you decide when it makes sense to stop working so you can maximize your payments.

A retirement planning specialist can help you run the numbers and figure out the best course of action based on your earnings and FRA, along with your spouse’s earnings and FRA. There are several calculators on the Social Security website that can help you model potential benefits. And remember that your Medicare Part B premiums are automatically deducted from your Social Security benefit payment, so the spendable payment you receive may be less than you expected.

Coordinate Social Security Benefits with Other Assets

After learning how Social Security works, and how to maximize your potential benefits, it’s important to understand how it might fit in with the rest of your nest egg. As you work with a retirement planning professional to determine the best course of action, they’ll review your other assets, including those in tax-advantaged retirement accounts like your workplace 401(k) and personal IRAs (including Roth IRA accounts). Generally, your withdrawals from these accounts will be taxable. The only exception is the Roth IRA [and/or Roth account in your 401(k)], which is generally tax-free in retirement.

If you take your Social Security payments and add your withdrawals from other accounts, you’ll start to determine how much you can spend each month in retirement. If you have a pension from your employer or an annuity payment, be sure to include those payments, too. 

Remember that you’ll be required to take certain withdrawals or distributions once you reach age 72. The required minimum distribution (called an “RMD”) applies to your workplace 401(k), profit-sharing or money purchase plan, 457, 403(b), SEP IRA, and SIMPLE IRA, if you have them. You’ll also have to take RMDs from your traditional IRA accounts, but not from your Roth IRAs.

The Long Haul

One of the primary benefits of Social Security is that the payment comes for as long as you and your spouse live. People tend to underestimate how long they will live, which can put them at risk later in life. Women tend to outlive men, and this lifetime payment can be crucial for the surviving spouse. Unless you and/or your spouse have serious health issues now, plan how you will meet your primary expenses until at least age 95. For long-life planning, it may make sense to withdraw more from some of your personal retirement accounts early in retirement, so that you can delay Social Security until FRA or age 70.

A retirement planning specialist can help you coordinate your tax-advantaged accounts and Social Security benefits with any taxable accounts and other assets you might have. With the help of a professional, you can make the most of your benefits and create a strategy that allows you to use your money effectively.