By: Scott Adair, CFP®, Wealth Management Advisor
Older Americans have two major benefits to consider as they approach retirement age: Social Security and Medicare. Social Security is an income benefit for retirees who have worked for at least ten years and have paid Social Security taxes. Social Security was created in 1935 in the midst of the Great Depression. Medicare was created in 1965, and provides significant health coverage for Americans age 65 and older. Both Social Security and Medicare are funded by payroll taxes. Known as FICA (Federal Insurance Contributions Act), the taxes are evenly split between employees and employers. People who are self-employed pay both portions, but can deduct half of the self-employment tax from their business income.
Social Security benefits generally replace about 40 percent of a person’s earnings, on average. While many Americans are fortunate enough to have additional sources of retirement income, Social Security benefits can still be a substantial income supplement. Social Security benefit amounts are calculated using a formula that is based on your average indexed monthly earnings over the course of your highest 35 years of earnings. You can get an estimate of what your monthly benefit will be at full retirement age from the Social Security Administration’s website (www.ssa.gov). Your full retirement age is determined by the year you were born. Currently, the ages range from 65 (for people born before 1938) and 67 (for people born in 1960 or later).
Deciding when to start taking Social Security benefits is important, and economic factors vary from person to person, affecting their decision. Every year you defer benefits beyond your full retirement age up to age 70, your benefit amount goes up by 8%. For this reason, many people defer taking benefits until age 70, especially those with family histories of longevity. Others who need the cash flow sooner than age 70 may decide to take benefits at their full retirement age. People also have the option of receiving benefits as early as age 62. However, since taking benefits before your full retirement age causes the benefit amount to be permanently reduced, this is generally not advisable.
In addition to your own retirement benefit, you may be eligible for a spousal benefit if you are married now or were married in the past. If you worked and are at least age 62, you can choose to take either your benefit or up to half of your spouse’s benefit at their full retirement age, whichever is greater. If you did not work and you are at least age 62, you are eligible for up to half of your spouse’s benefit at their full retirement age. To receive a spousal benefit, your spouse must be receiving their benefit. If you have been divorced for at least two years, you can apply for spousal benefits on your ex-spouse if the marriage lasted for 10 or more years. If the higher earner spouse with the bigger benefit dies first, the surviving spouse is entitled to receive their deceased spouse’s benefit, which replaces their own benefit.
For people whose only source of income is social security, it is unlikely that their benefit would be taxable. For people with additional sources of income, some of their Social Security benefit may be taxable. If the total income (adjusted gross income + non-taxable interest + half of your social security benefit) is from $25,000 – $34,000 for an individual return or from $32,000 – $44,000 for a joint return, 50% of the benefit may be taxed. People with total income exceeding $34,000 on a single return or $44,000 on a joint return may have to pay taxes on 85% of their benefit.
You can file for Social Security four months before you want your benefit to start. The rules on Social Security benefits and taxation can be more involved than what is covered in this overview. For your specific situation, it is best to consult with a financial advisor, or contact the Social Security Administration directly for assistance (www.ssa.gov).
When Americans reach age 65 they are eligible to begin receiving Medicare health insurance, regardless of income, medical history or current health status. The program was expanded by the government in 1972 to include certain people under age 65 who have a long-term disability. Medicare is funded primarily by general revenues, payroll tax contributions and beneficiary premiums. Medicare covers inpatient and outpatient hospital care, physician services and prescription drugs.
Medicare coverage is divided three main parts: Part A, Part B and Part D. People usually get Parts A and B directly from the government, and they get Part D through a private insurance broker. Another option is to get Part C (Medicare Advantage Program), which is a combination of Parts A, B & D. Medicare Part A covers hospital stays, skilled nursing facility stays, some home health visits and hospice care. Part A is generally free, though there is a $1,364 deductible (2019) that must be met before hospital or skilled nursing stays are covered. Part B covers certain doctors’ services, outpatient care, medical supplies, and preventive services. The standard monthly premium for Part B starts at $135.50 (2019), and goes up to as high as $460.50 for people with higher income. The premium is typically deducted from participant Social Security benefits checks. There is also a $185 deductible that must be met, after which most services are 80% covered (you pay 20% of the cost). Part D covers prescription drugs, and the average monthly premium is about $34.
To help pay for services not covered by Parts A and B, supplemental “gap” policies are also available. A Medigap policy only covers one person, and a monthly premium must be paid to the private insurance company that provides it. The best time to buy a Medigap policy is during your six month Medigap Open Enrollment Period, which starts on the first day of the month in which you are 65 or older and enrolled in Part B.
If you are planning on retiring before age 65, paying for health insurance before you are eligible for Medicare coverage will probably be one of your biggest costs. It is important to factor this cost into your retirement planning. If you continue working past the age of 65, you can still enroll in Parts A & B. If you are maintaining health insurance through your employer, you may need to contact the Social Security office and let them know you do not wish to enroll in Part B and pay that premium until you retire.
Medicare enrollment begins three months before your 65th birthday and lasts for seven months. As with Social Security, rules on Medicare can get complicated. Before making important decisions about your Medicare coverage, it is best to consult with a financial advisor who can help you navigate the process. You can also get a lot of good information from www.medicare.gov.
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