Social Security is a vital source of income for millions of Americans – 64 million of them, in fact. Nearly nine out of ten Americans age 65 or older receive Social Security benefits, and benefits represent 33% of income for the elderly. It will be the foundation of your retirement income, providing an inflation-proof, guaranteed income for the rest of your life.

But every year, many Americans make a fundamental mistake: taking Social Security benefits too early. In this article, we’ll cover some of the basics about how Social Security is calculated, when the ideal time to claim benefits is, and special strategies for spouses, divorcees, and widows.

What is Social Security?

Social Security is a government program designed to provide benefits to retirees and disabled persons. It also pays out benefits to the spouses and children of retired, disabled, and deceased workers. The vast majority of benefits – about 73% in 2019 – go to retired workers and their dependents.

Social Security started in 1935, with the signing of the Social Security Act by President Franklin D. Roosevelt, though it took some time before it became the program that we know today. For example, the earliest beneficiaries of Social Security received one lump sum payment when they retired, with an average payment of $58.06 (a little over $1000 in today’s money).

Monthly benefits began in 1940. Ida May Fuller of Ludlow, Vermont became the first worker to collect monthly benefits when she retired at age 65, receiving a check for $22.54. She lived to be 100 years old, collecting a total of $22,888.92 in Social Security benefits.

How is Social Security calculated?

Your Social Security benefits are based on the income you earned during your working years. The Social Security Administration takes the average of your 35 highest annual incomes and divides that number by twelve, coming up with your average indexed monthly earnings, or AIME. There is a minimum of 10 working years to qualify for a benefit.

The SSA then takes your AIME and puts it through another formula to determine your actual benefit amount. This formula changes every year, but your benefit will always be determined by the formula for the year you turn 62, the first year you’re eligible to receive benefits.

But there’s an extra level of complication on top of that. You only get the full benefits if you elect to start taking them at your full retirement age. Your full retirement age is based on when you were born – for example, for everyone born after 1960, your full retirement age is 67.

However, you can claim benefits anytime between the ages of 62 and 70. Electing to take benefits between 62 and your full retirement age benefits will result in reduction of your benefits. Waiting to take benefits until after your full retirement age will result in an increase in your benefit.

There are formulas for both the deduction and increase, but the easy way to think of it is that your monthly benefit increases 5% per year between 62 and full retirement age, and then by 8% per year until age 70. After age 70, there are no further increases, and no reason to wait to take benefits.¹

That’s why we recommend waiting as long as possible to start taking Social Security benefits. Remember, your benefit amount is a guaranteed, inflation-proof source of income that will last the rest of your life. It is the foundation of your retirement strategy, and ensuring that you receive the largest monthly benefit possible helps ensure that you can cover your fixed living needs throughout retirement.

Will Social Security go broke?

The biggest concern for many soon-to-be retirees is that Social Security is going to run out of money. This isn’t an irrational concern – the latest report from the trustees of Social Security and Medicare predict that the Social Security reserve fund will run out in 2035. That means that, unless we either raise taxes or reduce benefits, Social Security will be unable to pay its full benefits within the next two decades.

But does that mean you should claim your Social Security benefits early, in order to get as much income as possible before benefits are potentially reduced? The short answer is no – if your goal is to receive the highest Social Security benefit you can in retirement, permanently reducing your benefit now by claiming benefits early is counter-productive.

There are also several small changes that politicians could make that would go far to fix the system, without any cuts to benefits. Even if there are cuts to benefits, many proposed fixes to Social Security protect those age 55 and older, and if you do happen to be affected by any proposed cuts, your benefit would be reduced no matter when you started claiming it.

Are Social Security benefits taxed?

Social Security benefits are taxable based on your combined income level, which is half of your social security benefit plus your other income. For single filers, heads of household, and qualifying widows or widowers, the limit is $25,000 before you start getting taxed. For joint filers, the limit is $32,000.

If you’re receiving income from other sources – a job, a 401k, etc. – you may be subject to income taxes on some of your Social Security earnings. Benefits are never fully taxable (there is an 85% maximum, like regular income.

Can you work while receiving Social Security?

Yes – between age 62 and your full retirement age, you can earn up to $18,960 (for 2021) from your job before it impacts your Social Security benefits. This limit changes every year, but the effect is the same: any income you earn over that amount reduces your Social Security benefit by a dollar for every two dollars you earn. After your full retirement age, there is no impact on your Social Security benefits from working.

In short, if you are able to keep working before your full retirement age, you should wait to take Social Security benefits so that your monthly benefit amount can grow, especially if you earn more than $18,960 (in 2021).

When should you claim Social Security benefits?

You should wait as long as possible before claiming your Social Security benefits. No matter who you are, your possible benefit increases every month between ages 62 and 70. Social Security benefits are the foundation of any good retirement plan, and getting the largest monthly benefit possible helps ensure that you can cover your fixed living expenses for the rest of your life.

Additionally, if you’re in your highest earning working years in your early 60s, as many are, working a few extra years will permanently increase your Social Security benefits.

Many believe that they should start taking benefits as soon as possible, lest they die young and lose out on benefits they’ve earned. However, it’s much more likely that you’ll outlive your expectations, and end up punishing your future self by taking a reduced payment when you are younger.

Life expectancy has only increased every year since 1950, and if you’re taking care of yourself, it’s more likely that you’ll beat the averages than die young. If you’re retiring in your sixties, your retirement will likely last at least twenty years, and has a good chance of being thirty years long. Women also have longer life expectancies than men – don’t forget that if you’re married, your benefit will be passed on to your spouse after you die, so whether you die young or your spouse just outlives you, your family will still be getting the benefits you’ve earned.

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What are some additional benefit options if you’re married, widowed, or divorced?

Married folks have a few extra things to keep in mind when it comes to their benefits. First, if both spouses have claimed benefits, each is guaranteed half of what the other would get at their full retirement age. This can be a massive boost for couples where one spouse has out-earned the other, or one spouse stays at home.

Widows and widowers can choose to keep their own benefit, or claim what’s known as a “survivor benefit” that is equal to their spouses monthly retirement benefits. Survivor benefits are available as early as age 60, or 50 if disabled, but are reduced if claimed before your full retirement age.

Ex-spouses are also entitled to the above benefits if the marriage lasted 10 years or more.

Next steps: Social Security Statements and a financial advisor

First things first, get your Social Security statement! Your Social Security statement shows you how much you’ve paid in Social Security and Medicare taxes, and explains how much you would get in Social Security benefits when you’ve reached full retirement age. This is the best and easiest way to get this information, and you can get it online. If you’re over the age of 60, the Social Security Administration will mail you a statement annually.

After you get your statement, you should talk to a financial advisor, and no matter what, you should consult a financial advisor before electing to take Social Security benefits. A financial advisor can help you take a look at your whole financial picture, including pensions, 401(k)s, and other assets, and help you determine the best time to take your benefits.