Social Security is a primary building block of American retirement. Voters fret about it. Congress has borrowed $2.9 trillion from it. And 97% of older adults receive it. Social Security has become a critical part of modern life, economics, and retirement. But what do we really know about it? Let’s look at some of the basics and then discuss your retirement plan.

What is social security? What role can it play in your retirement plan? And how did it change in 2023?

What is Social Security?

President Franklin D. Roosevelt signed the Social Security Bill into law on August 14, 1935, in the depths of the Great Depression. Roosevelt's intention was to help meet the needs of old-age workers, widows, and people with disabilities. Almost 90 years later, Social Security has continued to fulfill this purpose. .

Social Security Defined

Social Security benefits are payments made by the US government to retired, disabled, or widowed individuals (or surviving dependents of those) who have paid into the Social Security system during their working years. Of the 67 million people who receive Social Security benefits in 2023, just over 51 million are retired Americans or their dependents. 

What Is the Average Social Security Benefit Amount?

The average Social Security benefit in 2022 is $1,614 per month or about $19,370 per year. The average among widows and people with disabilities was slightly less. Social security benefits do, however, vary widely based on work history, earnings, and age at retirement.

What Is the Maximum Social Security Benefit Amount?

The maximum Social Security benefit for an individual who retires at age 70 in 2023, is $4,555 monthly or $54,660 annually. If you retire at full retirement age the maximum benefit would be $3,627. However, this amount is only available to those who have earned the maximum taxable amount for Social Security (which in 2022, was roughly earnings of $133k) for the majority of their working life.

How Can You Increase Your Social Security Benefits?

You can employ several strategies to increase your Social Security benefits.

• Work and pay taxes for 35 years or more. Social Security benefits are calculated using your top 35 years of earnings.  

• Wait until age 70 to retire. This can result in a higher monthly benefit amount. For each month you delay starting Social Security benefits, your benefit will increase by a certain percentage. 

• Consider applying for spousal benefits early if you are a widow over age 62 and your spouse earned considerably more than you did. Surviving spouse benefits are calculated differently than standard retirement benefits. Talk to a professional to determine if taking early benefits makes sense. 

About 40% of older Americans rely on Social Security alone to pay their living expenses, but it's worth noting here that the benefits are modest. Most Americans will need more than Social Security to cover retirement expenses. Generally, Social Security covers roughly 40% to 50% of your pre-retirement income. Not to mention, there’s concern around the security of the program. So as financial expert, Dave Ramsey says, "You should think of Social Security benefits as icing on the cake of your retirement money, not the cake itself."

Nevertheless, Social Security remains a cornerstone of many people's retirement plans. If you are one of those people, you may be excited to know that starting in 2023, Social Security benefits are increased by 8.7%. This is the largest increase in benefits in decades.

Why Is the Government Raising Social Security Benefits in 2023?

The U.S. Social Security Administration calls the bump in rates a "cost-of-living adjustment" or COLA. A COLA is intended to help retirees keep up with the rising cost of living, in other words inflation. To determine exactly what percentage to raise benefits, the Social Security Administration relies on a figure called the Consumer Price Index for Urban Wage Earners and Clerical Workers, or CPI-W. 

When calculating 2023's increases, the government took the CPI-W from the third quarter of 2021 through the third quarter of 2022. Given the rapid inflation of 2022, it's no surprise the CPI-W indicated the need for a historic income boost.

Is this increase really all it seems to be? How could it affect you?

The Social Security Increase and Your Retirement Plan

It’s no surprise the increase in Social Security benefits may positively impact your retirement plan. We’ve all felt the increase in cost of goods this past year, but if you’re already retired and taking monthly distributions from your investment accounts, the increased Social Security amount may still mean you can take less from your investments each month. In particular this may be true for married couples who are both receiving Social Security. Keeping money invested in today’s market may allow you to benefit more from the future market upswing. If you are near retirement age, the higher benefit amount might provide a more stable income stream to help cover your living expenses.

While Social Security can play a key role in your retirement plan, it most likely should not be your entire strategy!

Many economists and political leaders are concerned about Social Security's longevity, and rightfully so. Currently, the Social Security Administration itself expects its trust fund to be depleted in 2041. 

That doesn't mean Social Security is going away, though. It means that the taxes paid by American workers will not cover the expenses incurred by Social Security. The program or taxes funding it will likely have to be modified for it to be saved.

The options for saving the program include decreasing benefits, increasing taxes, or raising the full retirement age (which is currently set at 67 for individuals born in 1960 or later). Many observers believe that the U.S. government will adopt a policy that combines all three of these options to keep the program solvent. Still, large increases in payouts from the trust fund are raising concerns about how quickly these modifications will need to be made — and what they will do to many Americans' retirement plans.

In the meantime, if you are retired or nearing retirement and expect to draw income from Social Security, you likely need a solid financial plan that incorporates (but doesn't rely on) Social Security.

What Are the Tax Implications of Receiving Social Security Benefits?

Until 1983, Social Security payments were excluded from federal income tax. Since 1984, however, 85% of Social Security benefits may be subject to federal income tax, depending on your total income and filing status. In addition to the federal government's tax, 13 states also tax Social Security benefits - California is not one of these states. Today, about 40% of people who receive benefits pay taxes on them. Unfortunately, for most of us who will require income in addition to Social Security, we will be included in that 40%.

If you owe Social Security taxes, you can ask the government to withhold taxes from your benefit check, pay estimated taxes, or settle up when you file your tax return with the IRS in the spring. If you're receiving income from an IRA, you may also consider increasing your IRA tax withholding to account for taxes due on Social Security income. Whatever you choose, it's important to consult with your advisor or tax professional to determine your tax liability and to plan accordingly.

How Can You Protect Your Social Security Benefits From Inflation?

Inflation can erode the purchasing power of your Social Security benefits over time. In 2022, inflation rose 6.5%, and consumer prices shot up 9.1%. Social Security benefits for 2023 increased by 8.7%.

While the cost of living adjustment (COLA) is intended to increase Social Security benefit amounts with the rate of inflation, this is not always the case. In 2022 COLA increased benefits by 5.9%, but for the five years preceding (2017-2021) COLA increases each year ranged from 0% - 2.8% with an average of 1.6%, while inflation for the same period ran roughly 2%. 

That's one reason most retirement plans should not rely on Social Security alone. Instead, you likely want to be free from consumer debt (credit cards) and hold a combination of 401(k), Roth IRA, IRA, rental property, or taxable investment accounts that can continue to provide income over your lifetime. Social Security often works best as a supplement in a retirement plan, not as its primary source of income. 

To protect against inflation, you may want to consider investing in assets that can provide a hedge against inflation, such as stocks, real estate, or commodities. Working with a financial professional can help you develop a retirement income strategy that’s designed to withstand the uncertainties ahead.

What Are Some Strategies for Investing Your Social Security Benefits?

If you have not started Social Security benefits - and expect to have more money than you need each month - consider delaying benefits until age 70. Remember, your social security benefit increases each year you wait to start taking benefits. That increase is a guaranteed amount for the rest of your life. 

If you are already drawing Social Security and have money left over each month, should you invest it in the stock market? 

If you have more coming in than you need, that may not be a bad idea. However, you want to ensure you have appropriate reserves before you do. Remember that you want to have at least a three to five year time-horizon to invest in the market. Additionally, if some of this excess is money from your investments, spending your Social Security benefits first and withdrawing less from your investment accounts is likely a better approach. Suppose you already take RMDs (Required Minimum Distributions) from your retirement accounts. In that case, the concept is the same - you can put this money in a taxable investment account instead of your bank account. 

What Are the Pros and Cons of Taking Social Security Benefits Early?

One of the biggest decisions you'll face when it comes to Social Security benefits is when to start claiming them. You can start receiving benefits as early as age 62. However, you are not entitled to your full benefit amount until you reach your full retirement age. If you are considering claiming your benefits at age 62, you are not alone. Research shows that 36% of American men and 39% of American women claim their benefits at age 62. 

In most cases, claiming benefits before full retirement age is less than ideal, but let’s look at some pros and cons. 

Why you may want to claim benefits early:

• Taking benefits early can provide the immediate income you might need.

• You do not believe you will live long enough to realize the benefits of waiting until full retirement age or age 70. 

• You think you can invest your social security benefits and beat the 6% to 8% annual increase you will receive by waiting. (This strategy could leave you seriously disappointed.)

Why you may want to wait to claim your benefits:

• Taking benefits before full retirement age will result in a lower monthly benefit amount. Your benefit may be reduced by as much as 30% below what it would have been if you waited until full retirement age. 

• The total amount you receive over your lifetime may be less. In general, if you live past your mid-70s, you were likely better off waiting until full retirement age.  

• If you're married, the benefit amount your surviving spouse receives, assuming you predecease them, might be less.

• If, instead, you delay receiving benefits until after full retirement age, it will result in a higher monthly benefit amount. Your monthly benefit will increase for each month you wait - and these adjustments are permanent. 

There are a number of things to consider when deciding when to begin Social Security benefits. Consult with a financial professional to determine the best strategy for your family.

Tips for Couples When Considering Social Security Benefits

For couples, it's important to consider how your individual Social Security benefits can be coordinated to provide maximum income. For example, a higher-earning spouse may want to delay claiming benefits until age 70 to maximize the monthly benefit amount, while a lower-earning spouse may want to claim benefits at full retirement age to provide immediate income. 

Additionally, couples should consider survivor benefits and how they can be coordinated to help ensure financial security for the surviving spouse.

Social Security benefits can provide a stable source of retirement income, but they may not be enough to cover your living expenses. Changes to the program are bound to happen in the future; it's unlikely they will occur in 2023, but they will be necessary for the program to continue. To supplement your benefits, you will want to consider other sources of retirement income, such as pensions, savings and investments, or part-time work.

The best strategy for maximizing your Social Security benefits will depend on your individual situation, including your age, longevity, work history, spouse, and other sources of retirement income. Consider working with a financial professional to develop a comprehensive retirement income strategy that takes into account all of these factors and more. 

At Cooke Wealth Management, we'd love to help you devise a personalized strategy that meets your unique needs and goals. Give us a call today!