Social Security benefits can go a long way in retirement, and millions of seniors depend on their monthly checks for at least part of their income.
According to a 2022 report from the Transamerica Center for Retirement Studies, nearly 1 in 4 workers say their benefits will be their main source of income upon retirement. That means it’s more important than ever to make sure you’re maximizing your monthly payments.
However, there are a few reasons why you may not receive as much as you expect. By understanding how these factors will affect your benefits, you can avoid being surprised at retirement.
1. State and Federal Taxes
Even if you retire, your distribution may still be subject to income tax. State taxes depend on where you live, and thankfully 38 states don’t tax Social Security. But if you live in a less tax-friendly state, be prepared to pay income tax on your monthly checks.
Regardless of where you live, your benefits may also be subject to federal taxes. How much you owe depends on a figure called your “provisional income,” which is half of your annual benefit amount, your adjusted gross income plus any non-taxable interest.
So, for example, if you receive $20,000 a year from Social Security and withdraw $30,000 a year from your 401(k), your preliminary income would be $40,000 a year.
If your provisional income exceeds $25,000 per year (or $32,000 per year for married couples filing taxes together), you owe federal taxes on up to 85% of your benefit amount. While you may not be able to evade Social Security taxes, it may be easier to prepare if you at least have a general idea of how much you owe.
2. Claim too early
The age at which you start claiming Social Security directly affects how much you receive each month, and the earlier you file, the lower your monthly payments will be. If you file a tax return as early as possible at the age of 62, your benefit will be reduced to 30%.
Claiming early isn’t always a bad idea, and there are situations where it can be a smart move. But filing early without realizing that it will lead to smaller checks each month can potentially create problems for your retirement.
3. Not knowing your correct full retirement age
Your full retirement age (FRA) is the age at which you receive the full benefit amount you are entitled to based on your income history. Your exact FRA will depend on the year you were born, but everyone’s falls between the ages of 66 and 67.
If you don’t know your FRA by heart, you’re not alone. Only 13% of adults can correctly name their FRA, according to a 2022 survey from the Nationwide Retirement Institute, and the average estimate among baby boomers is 63 years old.
If you are unsure of your FRA, it may affect your decision about when to apply for benefits. For example, if you think your FRA is 63, you can start claiming at that age because you believe you will receive your full benefit. In reality, however, you submit at least three years early, which will result in smaller payments per month.
Social Security can be complex and confusing at times, but it pays to understand as much as you can about how your benefits are calculated. Knowing how these factors affect your payments will make it easier to maximize your monthly checks.