What is Social Security and how does it work?
Social Security is a program run by the federal government that provides income for a wide range of Americans, including retirees, people with disabilities and families with a deceased spouse or parent.
As of 2024, 72.5 million Americans received a monthly benefit check from Social Security, of which 51.3 million were retirees, according to the Social Security Administration. Additionally, as of June 30, 2024, nearly 9 in 10 people aged 65 and over were receiving a benefit check, retired or not.
Here’s how Social Security works, how it’s funded and how it fits into your retirement plan.
What is Social Security and how does it work?
Social Security is a program championed by President Franklin Roosevelt as part of his New Deal series of plans. It was signed into law in August 1935. While the focus of the program today is providing monthly benefit checks for retirees, Social Security also offers vital financial support for others who may have difficulty supporting themselves, including:
- Those who are disabled.
- A spouse or child of a worker who died.
- A divorced spouse of a worker who died.
- A dependent parent of a worker who died.
- A spouse or child of an eligible recipient.
- A divorced spouse of someone eligible for benefits.
In short, Social Security offers help to those who may be unable to financially help themselves. You may be able to receive a benefit from Social Security at any age, depending on your circumstances.
In fact, Social Security pays more money to children than any other government program does.
To be eligible for benefits, most workers need to earn credits in the Social Security system. You earn these credits by working and paying your Social Security taxes, which are taken out of each paycheck. For 2024, you earn one credit for each $1,730 in earnings, with a maximum of four credits per year. Typically, the amount needed to earn a credit rises annually.
Most workers need 40 credits – that is, 10 years of work – to be eligible for benefits. Younger workers need to work for a shorter period of time to be eligible for disability or survivor benefits.
How is Social Security funded?
Social Security is funded with a payroll tax on workers and their employers. You pay tax on your earnings up to $168,600 (in 2024), and the rate varies depending on your employment status:
- If you work for someone else, you pay 6.2 percent and your employer pays 6.2 percent.
- If you’re self-employed, you pay the full tax, 12.4 percent of your income.
These taxes go into a trust fund, where they’re used to pay benefits of people receiving benefits today. The Social Security Administration says that approximately 88 percent of this money goes to benefits for retirees and their families, as well as to surviving spouses and children of workers who have died. The remaining 12 percent goes to people with disabilities and their families.
The administrative costs of the program are paid through the trust fund, but these costs are relatively low percentage-wise, less than 1 percent of the total money paid into the fund. This low overhead makes Social Security one of the most efficient government programs.
It’s also important to understand that the money you pay into the program isn’t held in an account designated for you and from which you will receive benefits later. These funds are paid out to current recipients, with the remainder put into the trust fund for later disbursement.
How much can you receive from Social Security?
While Social Security does provide a critical amount of income for many Americans, it was never intended to be a full retirement plan, according to the Social Security Administration.
The program replaces a portion of workers’ pre-retirement income based on their overall lifetime earnings. The actual benefit you’ll receive depends on how much you’ve contributed to the program during your working years and at what age you start to take your benefit (a point that inspires no end of planning and debate about the best time to start.)
If you take your full retirement benefit, here’s what percent of your pre-retirement income could be replaced by Social Security:
- Very low earners may expect to receive 78 percent of their working income.
- Medium earners may see about 42 percent of their working income.
- High earners might receive about 28 percent of their working income.
This Bankrate Social Security calculator can help you quickly estimate the benefits you may be eligible for.
How early retirement affects Social Security payments
You can start taking benefits as early as age 62, but your payout will be lower than if you start at full retirement age or later. Your full retirement age depends on the year you were born. For those born in 1960 or later, the full retirement age is 67.
If you retire early, your monthly benefit will be reduced for each month before your full retirement age:
- Your benefit is reduced by 5/9 of one percent for each month before full retirement age, up to 36 months.
- If you retire more than 36 months early, your benefit is reduced by 5/12 of one percent for each additional month, up to a total of 24 additional months.
For example, if you retire at age 62 and your full retirement age is 67, you’re retiring 60 months early. Here’s how much your benefit would be reduced in total:
- For the first period of 36 months, your benefit will be reduced 5/9 of one percent times 36, or 20 percent.
- For the other 24 months, you will incur a reduction of 5/12 of one percent times 24, or 10 percent.
So in total, your full retirement benefit at age 67 would be reduced by 30 percent at age 62. In other words, you’d receive just 70 percent of your full retirement benefit. So it can be costly, especially if you live long after you retire, to take your Social Security benefit as soon as you’re eligible.
Many financial advisors suggest workers will need at least 70 or 80 percent of their pre-retirement income for a comfortable retirement. So if you’re a higher earner and you want to keep your standard of living, you’ll need to turn to other sources of income, including employer-sponsored retirement plans such as a 401(k), an IRA and other taxable savings and investing accounts.
Frequently asked questions (FAQs)
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You can apply for Social Security benefits online, by phone at 1-800-772-1213 (TTY 1-800-325-0778), or in person at your local Social Security office (appointments are recommended). You should apply up to four months before you want benefits to begin.
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Full retirement age is when you can claim full Social Security benefits and varies by birth year. For those born between 1943-1954, it’s 66; for 1955-1959, it ranges from 66 and 2 months to 66 and 10 months; for 1960 or later, it’s 67. Claiming benefits before your full retirement age reduces them, while delaying past full retirement age increases until they max out at age 70.
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To receive Social Security retirement benefits, you need to have worked and paid into the system, earning a minimum of 40 credits, or about 10 years of work. If you’ve never worked, you aren’t eligible for benefits on your own record, but you may qualify for certain benefits as a nonworking spouse, ex-spouse or dependent of someone who has paid into the system.
Bottom line
Social Security can help you bridge the gap between your own retirement funds and financial stability in your golden years. But it’s key to remember that you’ll still need to stash money away on your own, since the program by itself likely won’t suffice for most workers.
— Bankrate’s Rachel Christian contributed to an update of this article.
