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SOCIAL SECURITY BENEFITS

 A 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 the Social Security Administration on any issues since only their decision counts.  Additional information can be obtained directly from them and on their website, www.socialsecurity.gov.  You can even calculate your own retirement benefit from their online Internet program as long as you have all of your earnings information at hand.  You can even calculate your benefits under various what-if scenarios by entering projected changes to your earnings. 

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 COLLECTING BENEFITS DUE TO 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 67 below. 

FACTORS INCREASING OR REDUCING YOUR RETIREMENT BENEFIT.

Receiving Benefits Before Full Retirement Age.  You can receive benefits at age 62, but at a reduced rate.  Your benefit is reduced by 5/9ths of one percent for the first 36 months you collect benefits before full retirement age, and 5/12 of one percent for subsequent months.  This currently equates to a reduction approximately 25% at age 62.  The closer you are to full retirement age, the smaller the reduction.  The age to receive the maximum benefits has increased to age 67, so the reduction at age 62 will increase.

Delaying Retirement Past Full Retirement Age.  You may delay collecting benefits until after full retirement Age.  As long as you are not receiving benefits, your benefit will be increased by a certain percent each month that you are past full retirement age until you reach age 70, up to a maximum of 8% per year with a 32% increase maximum.  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 66 CONTINUE TO BE THE RETIREMENT AGE TO RECEIVE FULL BENEFITS?

No.  The minimum retirement age to collect full benefits in 2013 was 66 years, and is scheduled to rise over the next few years, up to 67.  The age 62 early retirement option remains 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, if 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.

In addition to the basic benefit, under certain circumstances there are other benefits available.

            Spouse Benefits

            Disability Benefits

            Survivors Benefits

Each of these benefits has its own separate set of complex rules, so it would be beneficial to contact Social Security regarding each specific program that may apply to your.  There is also a Lump Sum Death Benefit of $255 that can be received but, unfortunately, you will not be around to spend it.

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.  Earned income 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 were age 62 through 66, you can have earned income up to $15,120 for 2013 and retain all of your social security benefits.  If you have earned income in excess of $15,120 during the year, you will have to repay social security benefits received in an amount equal to $1 for every $2 in excess of $15,120.  So, if you had earned income $17,120 during 2013, you would have to repay $1,000.  The maximum earned income amount is increased annually due to inflation. 

There is a special rule for earnings during the calendar year you reach full retirement age.  Generally, you can earn $40,080 (for 2013) during the months prior to the month of reaching full retirement age in the calendar year in which you attain full retirement age with no reduction in benefits.  Earnings above that level results in an amount equal to $1 for every $3 in excess of $40,080 being repaid to social security.  As an example, you reach full retirement age in May 2013, you could not earn more than $40,080 in the first four months of 2013, otherwise you become subject to the $1 repayment for every $3 over the limit.  Earnings after your full retirement age do not affect your benefits.   

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

ARE YOUR SOCIAL SECURITY BENEFITS INCOME TAX FREE? 

It depends.  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, capital gains, municipal bond interest, 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, are $25,000 or less, your social security benefits are usually 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 the tax filing status of married filing separately is claimed, 85% of the benefits 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 after age 55, $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.  

JUST A SIDE NOTE ON MEDICARE.

Even though you may not be collecting social security benefits at age 65, you must register for Medicare at that age.  If you begin collecting social security benefits before age 65, you are not entitled to Medicare until you reach age 65, unless it is available due to a disability. 

IRS required disclaimer:  IRS regulations require us to advise you that, unless otherwise specifically noted, any tax advice contained in this communication (including any attachments, enclosures, or other accompanying materials) was not intended or written to be used, and it cannot be used, by any taxpayer for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions; furthermore, this communication was not intended or written to support the promotion or marketing of any transaction or matters it addresses.

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