How Does Social Security Work?

Published In Government Programs

February 12th, 2016

Social Security, also known as the Old-Age, Survivors, and Disability Insurance (OASDI) is a federal program that includes several insurance and welfare programs. The original Social Security Act was signed into law by President Franklin Roosevelt in 1935 and the current version of the Act has been amended numerous times.

Social Security is funded through payroll taxes or a self-employed contributions tax. Tax deposits are collected by the Internal Revenue Service (IRS) and are formally entrusted to a federal trust fund that supports Social Security.

According to the Social Security Administration, the total Social Security expenditures in 2013 were $1.3 trillion, which translates to over 8% of the GNP and more than a third (37%) of Federal expenditures.

Benefits

The amount of the monthly Social Security benefit a worker is entitled to depends upon their earnings record, the amount of taxes they have paid, and the age at which the retiree chooses to begin receiving benefits. In 1937, the number of people receiving Social Security benefits numbered 53,236. The annual expenditure for benefits that year amounted to $1,278,000. In 2015, Social Security paid out $73,522,000 to more than 56 million people. The average monthly benefit is $1,227.

And this benefit is critical to the financial health of millions of Americans. A recent publication available through AARP (AARP Bulletin, Dec, 2015) suggests that Social Security kept over 25 million Americans of all ages out of poverty in 2013.

Cost of Living Adjustment (COLA)

Each year, the increase in benefits (called the cost of living adjustment or inflation adjustment) is calculated on the consumer price index. When that index does not increase in the prior year (in this case 2015), the benefit (for 2016) does not go up. Congress started requiring annual cost of living adjustments in 1975, and since that time an upward adjustment in the COLA has failed to happen only three times – in 2010, 2011, and now 2016.

Proposed Changes to Social Security

Trustees in charge of the Social Security Trust Fund anticipate that the fund will run out of reserves in 2033. While this does not mean the system will go broke, the implication is that the Trust Fund will not be able to live up to 100% of its financial commitments to its beneficiaries. A number of proposals have been made in the past to make changes to the system to make it more financially viable for the long term. Those proposals include:

  • Put a hold on the amount of the monthly benefit either through eliminating the cost of living adjustment or reducing the monthly payment itself.
  • Increase the retirement age so that beneficiaries have to wait to file and receive benefits.
  • Reduce the number and amount of benefits that are available to dependents.
  • Raise the payroll tax to increase the amount of money flowing into the Trust Fund.
  • Increase the tax on benefits.

Each of these options has its detractors and supporters and the debate around each is complicated by emotional, political, and economic factors.

Maximizing Your Social Security

There are a number of ways to maximize your social security benefit and make the most of it.

  • Work longer – the longer you work the greater your benefit. Social Security figures your benefit by calculating your average earnings during your most productive 35 years.
  • Don’t retire early – if you work beyond full retirement age, you receive a bonus of approximately 8%, up to age 70.
  • Stay healthy – the longer you live, the more benefits you receive.
  • Live in a tax friendly state – some states tax your Social Security benefits and some do not.

Calculating Your Social Security Benefit

Several good resources exist for calculating your benefit under the Social Security Program.

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