Social Security Explained for Early Retirees: Taxes, Timing & Strategies

In this episode of The Retire Early Retire Now podcast, host Hunter Kelly, a certified financial planner, discusses everything you need to know about Social Security with a focus on early retirement. The episode covers the basics of Social Security, including how it is calculated and taxed, as well as strategic considerations for maximizing your benefits. Key points include the impact of early retirement on Social Security, the tax implications, planning opportunities for self-employed individuals, and factors to consider when deciding when to start receiving benefits. Listeners also get practical advice on how to manage their finances to optimize Social Security payouts, and a sneak peek into next week's topic on distribution strategies for an early retirement. Don't forget to leave a five-star review and share the podcast for more financial insights.

00:00 Welcome to The Retire Early Retire Now Podcast
00:27 Introduction to Social Security for Early Retirement
00:51 Understanding Social Security Basics
01:06 Maximizing Your Social Security Benefits
01:39 Listener Reviews and Podcast Growth
02:34 How Social Security is Calculated
04:35 Paying into Social Security: Taxes Explained
06:54 Self-Employment and Social Security Contributions
10:38 Calculating Your Social Security Benefit
13:06 When to Take Social Security: Key Considerations
19:06 Conclusion and Next Week's Topic

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Transcript

0:00

And welcome back to The Retire Early Retire Now podcast. This is the podcast where we dive deep into all strategies that will help you achieve financial freedom sooner, live better, and take control of your retirement. I'm your host, hunter Kelly, certified financial planner, and today we're gonna talk all things social security geared around in early retirement. And so over the last few weeks, we have been. Going through the accumulation phase, how do we plan for an early retirement? Last week we started talking about tax strategies as you transition into retirement, and now we're going to start talking about social security and what you should think about, uh, for that early retirement. And we'll wrap it up all next week and kind of do a big case study on, hey, what does it look like to retire early? Right? And so, um, again, today we're gonna talk about all things social security. So what you'll learn today is. One, what is social security? How do we pay in, uh, gen in very simple terms, how is it calculated? Um, and then. What are some things that we should think about as we are planning for that early retirement? So, uh, always want to make sure that, uh, you are maximizing your social security benefits. You spend potentially 20, 30, 40, 50 years paying into social security. So we wanna make sure that you can maximize that because it is your money, right? Um, and so everybody has their thoughts and feelings. Uh, whether logical or not on what social security is gonna do over time, but for this episode, we're gonna assume that it's gonna be here to stay. Uh, and so we wanna make sure that we maximize that benefit. Uh, but before we do that, I just wanna give a, a couple shout outs to, uh, some reviews that we have received recently. So this has been helping the podcast grow tremendously. So if you're liking this podcast. Go ahead and leave a five star review. Natalie wrote, great podcast, so informative. I have my whole family listening. So hopefully Natalie and her family are getting some value out of this podcast. Uh, again, this is why we do it. We wanna make sure that we're helping you, uh, plan and get educated up on, uh, all things financial so that you can enjoy, uh, a fulfilled life, whether that's retiring early or doing something that you enjoy more if you're not happy at your current job. And so giving you that financial freedom and flexibility is what this podcast is about. So again, if you like this podcast, share it with a friend and leave a five star review. But let's jump into today's topic. So social security, uh, again, uh, let's talk about what social security is and how it's calculated. So most people know that social security is, uh, a form of a government subsidized pension. So when you turn of a certain age, anywhere from 62 to age 70, the government will pay you a lifetime benefit, uh, until you're passing. And so. Uh, if you start taking it social, uh, 62, your social security benefit will be reduced. Uh, right now, if you were born after 1960, your full retirement age. So when you receive your full, full benefit, I. Is at age 67. Uh, so my thoughts are that that will continue to be pushed back over time, uh, given the situation, uh, in the government with social Security. But we will see, um, and then you can always delay until age 70. And if you do that, you'll generally get about a 8% increase. Um, so if you take it 62 versus 70. You'll have about a 77% increase from age 62 to 70, uh, if you hold out. So sometimes it does make sense to wait until age 70 and we'll talk about, uh, scenarios when it does here in just a little bit. Um, but that's generally how social security works. You pay in for, uh, through your, uh, based off your wages you pay into, uh, the social security fund. And then when you become of age, you can start to receive that benefit. And so, um. Generally in the private world, this is what we call a defined benefit plan. So if you had a, if you're of an age where you have a traditional, uh, pension or you work at an employer that has a traditional benefit, uh, sometimes they will require you to pay in. Um, and then you'll have some sort of pension at potentially age 62, uh, sometimes even earlier, depending on what the plan is like. So this is essentially the same thing, but it is government subsidized. No surprise. And so how do we pay into social security? This is where things start to get, uh, confusing to some people. So as I explain it to friends and family, uh, prospective clients and clients, uh, sometimes I get the googly eyes and they're like, oh, we pay extra on top of our income tax, uh, to social security. And it's like, yes. Okay. So, uh, this is. I would say most people know this, but it is sometimes a common misconception. So you have really three taxes that you're paying on your wages, right? So you have your federal income tax, and that is the one that gets all the news all the time, um, is, uh, federal income tax. So those brackets start at 10% and they worked their way up to 37.5%. So it is a progressive system, so as you make more, you will pay more on those top dollars. Right? And so if you're making a hundred thousand dollars filing jointly, that that marginal tax bracket will be 22%. If you're making, let's call it$400,000, that marginal tax bracket will be 24%. And as you work up, it'll work up to 37.5%. Um, and so that will go on forever. So if you're making 3 million, 4 million, 5 million, um, you will continue to pay. Uh. More and more tax, uh, for that federal income tax. And there's more complexity there. But that's the, simple way of saying that. Now, the other two taxes that sometimes people forget to consider is, what they call fica or Social Security and Medicare. And that generally works out to be 15.3%. And so if you're an employee of an employer. Your employer will pay half of that. So, uh, if you're making two,$300,000 a year, you're getting an extra, call it 10 to$15,000 of compensation because they're paying that portion of your, FICA taxes. And so I. just for the social security, that is 12.4%. So the employee meaning, meaning you will pay 6.2% and your employer will pay the other 6.2%. Unfortunately, if you're self-employed, you'll pay all 12.4%, right? Because there's no employer, you are the employer. And so that's what they call self-employment tax, and so with Social Security, it actually gets capped out at, for 2025, it'll be$168,000. Actually, I think it's a hundred sixty eight, six hundred, once you hit that, if you're making three,$400,000 a year, you'll notice sometime in June, July, August. That your, paycheck will increase, because they're not withholding, that, social security. That social security tax anymore. So that's something you can plan for during the year, if that's what you wanna put more to savings, maybe a brokerage account or add to your 401k or whatever that may be. if you're making above$168,000, it is very likely that your pay will increase at some point during the year. so that's something that you can look forward to. Maybe that's Christmas money or whatever you wanna do with it, but I just know that. If you're making over that amount, you'll have a little bit extra in your paycheck. for us, self-employed people that have to pay the full 12.4 or 15.3 if you're considering Medicare as well. the government does help out a little bit. And you get a deduction on your federal income tax from the amount of self-employment that you pay. So how does that work? so if you, let's say if you make a hundred thousand dollars of self-employment income, your self-employment tax, including Medicare, will be 15. Thousand$300. they will, the government allows you to take a deduction of half of that, so you'll be able to deduct off your federal income tax or your, above the line deduction, so off of your income, seven$7,650. So again, if you are paying in 15,300. To in self-employment tax, you can deduct from your income 7,650 from the federal income tax. Okay? Even if you do not itemize. So that is what we call a, an above the line deduction. So if you're self-employed, you do get a little bit of help there. So that's how social security is taxed. you're gonna pay that 12 point. 4% or 6.2 with the employer help on the other half, all the way up until,$168,000 and some change. And so that's what you want to consider. Now, some things, just a few other things to consider if you're self-employed, if you are, If you're self-employed and you're sole proprietor or you're an S corp and you're making your income look lower on paper through deductions or what you think your fair wage, W2 wage would be because of S corp and taking profits and all that. you just need to be very cautious that, if on paper your income is below, your, what your actual take home pay is because of, doing some of those tax planning strategies. Just know that you are kind of hurting yourself on the backend for that social security benefit. Now, if it's something that you're not planning on having later on down the road, you don't need to worry about it, then keep, keep on, keep it on. But just be aware that if your, take home is 200,000, but you're, but you're an S corp and you're paying yourself a wage of let's say 40,000 for whatever reason, I'm just using round numbers. talk to a tax advisor about your specific situation. But, if you're taking a, income much lower than that, then you're only gonna pay, social security tax on that 40,000 in this particular scenario. you, your benefit may be a bit lower than, what you originally thought it would be. So just keep that in mind. Now, how is your benefit calculated as you move forward? So you're paying in, you're paying your 15.3% or or half of that, toward, social security And so the next part of that is that, the government is gonna take. The average of your highest 35 years. And so this becomes potentially a planning opportunity or something of concern if you're retiring early because maybe, you're in med school, you're in college, you didn't really start working until 25, 26, 27, 30, whatever that case may be because you were in school and you were fortunate enough not to have to work or you're just too busy to work, whatever that may be. And you wanna retire in your fifties. Well, maybe that only puts you at 25 or 30 years of work, right? And you're expecting a higher social security benefit. Well, if, if you retire early and you only have 25 or 30 years, those other years that you're retired and lead up to 35 years, the government is going to just assume that it's going to be zero. Right? Again, let's say you have 25 years of, maxed out social security, wages at, call it an average of$168,000 for sake of numbers. Well, those next, five to 10 years of you not working are gonna be considered zero. So your benefit is going to decrease over time. So some of the things that you can consider to do. One is to work a little bit longer, right? which again, we're, we're all talking about retiring early. So if it's not something you're banking on. Like, make sure you have a plan for it and just go ahead and retire and you'll figure out the social security later on down the road. Right. Um, the other thing is that you could say, okay, well I am banking on social security. I'm banking on a certain amount of benefit. consider going part-time, right. Uh, or finding a job where maybe it's a volunteer type deal, but you are still getting paid so you can pay into social security and not receive zeros for those certain amount of years, right? And so whether that be five or 10 years, uh, if you're doing some sort of part-time work, uh, you can still get, some credit towards social security'cause you'll be paying in, right? And so those are some things to consider Now let's transition into what to consider when deciding when to take Social Security, how to take Social security and what is involved in that. And so if you're still. 10, 15, 20 years away from taking Social Security. This may not mean much to you'cause things may change in that time period. whether that's moving back the benefit date, or full retirement age, or just something that you may not want to consider. But If you were five years or closer to retirement, this is something you would certainly want to start to consider and start to come up with at least some sort of plan, on how you want to take Social Security. And so here are a couple things that you want to consider when thinking about taking Social Security. One is your health, right? are you healthy? Do you have any? high blood pressure or things that would make your life expectancy lower than the average, right? And so if that is the case, then you would want to take earlier. but if you're very healthy, you have a family history of living, well past the expect or the life expectancy age, then you would want to maybe. Take later. Right? the second thing obviously would be to consider family history and then also your spouse. So when thinking about your spouse, if your spouse did not work, or if they, they're either currently working, you would want to consider, Hey, should I hold off intake later so that their benefit is, higher if maybe, if they're younger than me? and I am most likely going to pass before them. this would give them a higher benefit later on down the road. we want to consider our spouse. Next would be how we're taking our distributions. So are we using IRAs? Are we using brokerage accounts? Are we using 4 0 1 Ks? Where is that money coming from and how is it taxed? Right? And so that'll determine, especially if we're wanting to take early. that will determine how our, our benefit is taxed. And so if you're, if you're 62 and you're considering taking, but you're taking. a lot of your distributions, so supplement income from pre-taxed IRAs, then your social security will be taxed. Or 80% of your total social security will be taxed at your, ordinary income rate. that could drive that, benefit down because of those taxes, right? And so you may want to wait at that point because the benefit may not be as high as you thought it would be because of taxes. Now, if you're taking. from cash or brokerage accounts, where on paper your ordinary income is quite low, and you can avoid having that 80% tax or 80% of your social security tax, then. The benefit might be worth it at a, at a younger age than full retirement age. these are all things that you could, should consider tax situation distributions, how you're taking those distributions, can all play into, when you should take that. Now I'm always in the mindset of get it as early as reasonably possible again, because you have paid in for multiple decades. it is your money. and so make sure that you get the value of that because tomorrow is not promised. You take, you get one month of social security, you pass away, all of that money would be left to the government essentially. now you want to take it as early as possible while also considering those other factors like health, family, history of health, spouse, tax situation and distributions. all those things you want to consider will help you determine, when you should take it. And again, just as a reminder, you can start taking at 62, the full retirement age as it currently stands is 67. And you can always wait until age 70 to continue to, or to start that benefit. And so the difference is that if you take it 62, that is going to be a reduced rate. Then, the number that you're seeing at age 67, and if you wait until age 70, you'll get about an 8% increase from that full retirement age benefit, each year. So three years of about an 8% increase, which. could make a big difference, right? So maybe early on you take heavier from your savings, investments, retirement accounts, things of that nature, knowing that you're gonna wait until age 70 and then your social security would take a large burden off of those distributions. and so again, those are all things to consider. if you're not good health or you just have, You just want to take it earlier, you can always take it earlier. Just know that you're gonna have a reduced benefit. the last thing to consider there is sort of your breakeven point. So again, the earlier you take, I. Versus the later you take. So, um, if you take early your break even point, to basically comparing it to your full social security, what does that look like, right? So is it 82? Is it 85? should I have waited? So again, the longer you're going to live, the later you want to take, right? If you find that breakeven point, to be around 80 and you feel that you're going to exceed 80, well then I would wait, right? Because then it would make more sense to take a higher benefit earlier or wait to take that social security later, because you'll receive a higher benefit. But if your breakeven point is. let's say 82 or 83, and you feel that, with family history and your current health, you're not living past 75, well, then you would want to take it earlier. And so again, some food for thought. most of you may be, a little bit, A little bit of ways from making these decisions, but I thought it would be helpful to the conversation today. and obviously for those that are a little bit closer, certainly helpful in the conversation. But next week we will talk about how to take distributions once we start our early retirement. So, considering. retiring from age 50 to 55, anytime before age 59 and a half. your distributions may look a little bit different than someone retiring at 65. So we're gonna talk about all things distributions, kind of wrap that up and talk about all of these different strategies that we've talked about over the last few weeks. So I'm excited about next week's podcast, and again, if you like this podcast, go ahead and share it with a friend. Leave a five star review on your favorite podcasting app, and we will see you in the next one. This podcast is for educational purposes only. It's not meant to be financial, tax or legal advice. Do not make decisions solely based on this podcast alone. Please seek professional help when considering your own situation, and please keep Palm Valley wealth management in mind when making those considerations.