How Does Social Security Work?
Whether you’re just starting your career or ready to attend your retirement party, it is important for you to understand how Social Security works. Doing so will help you prepare for a fun and carefree retirement. Despite all of the Social Security resources, there is a lot of confusion about how Social Security works. So, let’s take a look at how Social Security works.
Social Security Taxes and Eligibility
Social Security works by collecting the American workforce’s tax contributions and then using them to pay out benefits to eligible people. If you’re a citizen of the United States, you’re eligible for retirement assistance through Social Security. It was created to provide retirement assistance for U.S. employees who pay FICA taxes. The Social Security Administration collects a total of 12.4% tax on earnings. In other words, your employer pays 6.2% and you pay 6.2% to fund Social Security benefits. For example, let’s say you pay Social Security taxes. You can earn up to four “tax credits” per year, according to your income level:
- $1,360 in wages will earn you one credit, or
- $5,440 in wages will earn you the maximum four credits.
All in all, Social Security requires you to earn 40 credits to be eligible for retirement benefits (or 10 years of work minimum).
What Social Security Wages Are Used?
Your lifetime earnings are used to calculate your benefit amount. Each year of earnings is recorded in the Social Security system. Your actual earnings are adjusted to account for changes in average wages since your wages were earned – that is, they are indexed. For example,
- $24,000 earned in 1997 x (change rate since 1997 to calculated year) = adjusted wage
If you want to calculate your average indexed monthly income, you’ll need up to 35 years of earnings. After the Social Security Office determines how many years you’ve earned wages, they will:
- Select the years with the highest earnings
- Sum the indexed earnings and divide the total amount by the total number of months in those years
- Round the average amount down to the nearest dollar
And there you have it – your average indexed monthly income.