How Social Security Works - A Comprehensive Explainer

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Social Security is a critical U.S. social insurance that provides a safety net for millions of Americans. Primarily, this program delivers monthly payments to eligible individuals and their families. It’s so important that we’ve written several articles about it, which you can find in our Social Security hub.

There are three types of benefits:

  • Retirement Benefits: This is the most well-known benefit. It replaces a portion of your pre-retirement income when you stop working after retirement age. 
  • Disability Benefits: These benefits offer financial support if you have a medical condition that prevents you from working or severely limits your earning ability. 
  • Survivor Benefits: These benefits provide financial help to children, spouses, and other dependents when they lose a family member who was contributing to Social Security. 

For a more comprehensive look at these three different types of Social Security, we have a complete explainer you can browse. 

Understanding your benefits and how they work is vital. Social security is a major source of income for retirees, forming a significant portion of their post-retirement income. Planning for social security can help you maximize it and understand what you can expect to get after you retire. Many factors adjust your retirement income, like your lifetime earnings and age. 

We’ll explore all of these factors and more below, providing you with a comprehensive understanding of how Social Security works. We got all of our information straight from the official Social Security website, ensuring it is up-to-date and accurate. 

Types of Social Security Benefits: A Breakdown

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Your monthly Social Security benefit goes up the longer you wait to retire. It goes up slowly right after retirement age, speeding up as you approach 70.

Social Security offers several benefits to meet the needs of individuals and their families. There are three main benefits, which can most easily be divided into four categories. Let’s quickly take a look at each type:

Retirement Benefits

You become eligible for retirement benefits after you reach the age of 62. However, it is best to wait until you reach full retirement age, which usually ranges from 65 to 67. It depends on your birth year. If you retire before your full retirement age, you permanently reduce your benefit amount. Delaying retirement can increase your monthly benefit, though. 

Your benefit is calculated based on your Average Indexed Monthly Earnings and full retirement age. The higher your earnings, the higher your monthly benefits will be. 

Spouses married to a retiree for at least 10 years are also eligible for spousal benefits based on their spouse’s retirement benefits. You can sometimes receive up to 50% of the retiree’s benefit. 

Disability Benefits

Disability benefits are available to individuals with medical conditions that prevent them from working (or limit their abilities enough to substantially lower their earnings). To qualify, you must have a sufficient work history (including recent work credits) and meet the SSA’s definition of disabled. 

There are two main types of disability benefits: Social Security Disability Insurance (SSDI) and Supplemental Security Income (SSI). What most people think of as “disability benefits” is just this first portion. SSDI provides benefits to those with a sufficient work history. SSI provides benefits to individuals with disabilities who have limited income and resources, such as those who were born disabled. 

SSDI is calculated based on your average covered earnings before you became disabled. 

Supplement Security Income

Technically, this is part of disability benefits. It is for those who are disabled, after all. However, it functions differently and is funded differently. Therefore, it is often categorized differently. 

SSI is technically a federal program funded through general tax revenue  – not Social Security tax. 

This program provides benefits to low-income adults and children with disabilities, as well as low-income elderly individuals. The benefit is based on a federal benefit rate and adjusted annually for cost-of-living increases. It is not based on income, and you do not have to have sufficient work experience. 

SSI serves as a safety net for individuals who are born disabled or become disabled before they qualify for SSDI. It also works for those who have low income and don’t qualify for substantial benefits through SSDI. 

Survivor Benefits

Survivor benefits assist spouses, young children, and dependent parents of deceased workers. If the deceased worker was receiving Social Security retirement or disability benefits, they are available. If the deceased worker had enough work credits at their death, they are also available. 

There are three main types of survivor benefits:

  • Spousal Benefits: A surviving spouse may be eligible for a benefit based on their deceased spouse’s work history or disability benefits. The specific amount depends on the spouse’s age and marital history. 
  • Children’s Benefits: Unmarried children under 18 (or 19 if the children are still attending school full-time) of a deceased worker may be eligible for benefits based on the deceased worker’s earnings record. 
  • Parent’s Benefits: Dependent parents aged 62 or older who have lost a child who previously provided at least half of their support may also be eligible for benefits. These benefits are based on the deceased child’s earning records. 

Earning Social Security Benefits

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You’ll pay Social Security taxes while working, funding the Social Security program.

You must meet several requirements to be eligible for most Social Security. Often, these requirements are related to your work history and age. 

Earning Retirement Benefits

To qualify for any Social Security retirement benefits, you generally need a minimum of 40 work credits. You earn one credit for each $1,730 (though this amount varies by year). You can only receive a maximum of 4 credits each year, so you must work a minimum of 10 years to qualify. The amount you must earn to receive a credit usually goes up yearly to keep pace with wage growth. 

To receive retirement benefits, you should preferably be full retirement age. The exact age that counts as “full retirement” varies, though. The full retirement age gradually increases for people born after 1943. Your full retirement age will be based on your birth year, and you can calculate it on the SSA website. 

You can choose to start receiving retirement benefits as early as age 62. However, this will permanently reduce your monthly benefit amount. Your benefit is decreased for each month you claim social security before full retirement age. 

You can also wait past your full retirement age. In this case, your monthly benefit increases for each month you wait for compensation. Typically, your benefits stop increasing at 70, though. This option may be suitable if you expect to have a long lifespan, have a job you love, or want to maximize your monthly income.

Earning Disability Benefits

For other benefits, it’s a bit different. For disability, you must pass a recent work test that’s based on your age. Before age 24, you must have earned 6 credits in a 3-year period when your disability starts.

Between 24 and 31, you’re often eligible if you’ve worked half the time after age 24 and your current age. After age 31, you must have at least 20 credits earned in the last 10-year period. 

There is also a required minimum number of credits, which you can see on the official Social Security website

Social Security Taxes

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While you may not like to pay taxes now, it helps ensure that Social Security will be available when you retire.

Social Security is funded through taxes. It’s a pay-as-you-go system, which means that the current workers’ taxes fund the benefits for current beneficiaries. The taxes you pay in are not sitting in a bank somewhere. 

The current Social Security tax rate is 12.4%. However, this is split evenly between employees and employers, with both contributing 6.2%. That means that for every dollar you earn (up to the current limit), 6.2 cents goes to Social Security. Your employer pays another 6.2 cents.

However, there is a limit on the amount of Social Security tax you can pay. This limit is called the “taxable wage base,” and it is adjusted annually. In 2024, this limit is $168,600. After you make more than this, you do not pay any more Social Security taxes on further income. 

Self-employed individuals must pay both the employee and employer share of Social Security taxes. In other words, they must pay 12.4% of their self-employment income. 

In addition to Social Security taxes, you’ll also need to pay for Medicare (which is a similar but separate program). This tax is 2.9% and is split between the employee and employer. Both pay 1.45%.

All excess collected Social Security taxes are put into a trust fund. These funds are dipped into whenever the collected taxes are lower than what’s needed for beneficiaries. 

The long-term stability of Social Security is a topic of debate. Currently, the SSA has reported that the cost of Social Security will rise substantially over the next decade. By 2035, the Social Security tax will only be able to pay 75% of the expected benefits.

This increased cost is due to population aging – not because people live longer, but because the birth rate has declined. There will be too many retirees and not enough workers to pay taxes. 

Calculating Your Benefit Amount

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Using the SSA’s online tools is the easiest way to estimate your potential monthly benefits.

Social Security uses a specific formula to determine your monthly benefit after retirement. This formula considered several factors, including your average lifetime earnings and inflation. Here’s the information you need to consider:

  • Average Indexed Monthly Earnings (AIME): First, you need your highest 35 years of earnings (indexed for inflation). Take the average of these 35 years. This indexing takes into account the average wage overtime, ensuring that your past earnings receive fair compensation. 
  • Benefit Formula: The SSA applies a formula to your AIME, which provides them with the Primary Insurance Amount (PIA). A higher AIME will result in a larger PIA compared to a lower AIME. In other words, the more you earn over your top 35 years, the more your monthly benefit will be. The exact formula utilized changes regularly. Usually, your monthly benefit increases quickly for those with lower income, slowing down for higher earners. You can get a benefits estimate on the SSA website
  • Full Retirement Age: You also need to consider your age. Those who reach full retirement age before receiving benefits will receive their full monthly amount. If you choose to retire early, your monthly benefits will be permanently reduced. After all, you’ll need to spread out your monthly benefit over more years. At the same time, delaying retirement age increases your monthly benefits.

Practical Considerations

This is great, but what does it mean for the average retiree? If you want to maximize your monthly Social Security benefit, here’s what you need to know:

  • Higher Earnings = Higher Benefit: The more you earn while working, the higher your monthly benefit will be. It isn’t a 1-to-1 correlation, but if you’re a lower-income worker, just increasing your income a little can make a sizable impact. 
  • Early vs. Late Retirement: Claiming benefits before your full retirement age permanently reduces your monthly amount. However, your benefits are increased if you wait past your full retirement age. This decision is a careful balancing act between your working ability and your financial needs. 

Your Social Security benefit may be lessened if you have a pension from a non-covered government job on top of Social Security. This is called the Windfall Elimination Provision. Your benefits could also be reduced if you worked for the federal government or had a spouse who was a federal employee. 

Helpful SSA Resources

There are several resources on the Social Security Association website that could help you estimate your potential retirement benefit:

  • Social Security Statement: This document summarizes your earnings history and an estimated benefit amount based on this information. You can access this information online by creating a Social Security account
  • Retirement Benefits Estimator: This online tool allows you to estimate your benefits based on when you expect to retire and make. You can test different scenarios to see how they change your monthly benefit. 

Planning for Social Security Retirement

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Careful planning is the best way to ensure that your retirement goes smoothly.

When planning to retire, you must plan for Social Security properly. To maximize it’s effectiveness, it’s important to plan well. Below, we’ll quickly review a few strategies you should consider when maximizing your Social Security. 

1. Estimate Your Benefit Amount

Firstly, you need to estimate your benefit amount. There are two ways to do this (or, preferably, two resources you should use concurrently). The first is your Social Security Statement, which gives you an estimate of your retirement benefits once you reach full retirement age. If you haven’t already done so, you must make an account. 

The Retirement Benefits Estimator also allows you to explore different retirement ages and earnings scenarios and see how life changes might impact you. 

2. Consider Your Retirement Age

You become eligible for full benefits at your full retirement age, which varies depending on when you were born. (For many retiring now, it is between 65 and 67.) Retiring before you reach this age might seem like a good idea, but it can permanently reduce your monthly benefits. Delaying your retirement past this age can slightly increase it (this dissipates at 70).

Evaluate how much money you need after retirement and how much you can get from Social Security. You may be able to take a lower benefit and retire early, or you may need a higher benefit and may need to retire later. 

If you have health concerns, you may be unable to make the best financial decision. Sometimes, life gets in the way. External factors may influence your ideal retirement age. It isn’t all about the money (if it was, everyone would just retire at 70).

3. Maximizing Your Earnings Potential

Generally, the more you earn through your career, the higher your monthly benefits will be. Look for opportunities to take career advancement or other higher-paying jobs. Remember, only your top 35 years are considered. 

Consider retiring later, if possible. The later you retire, the higher your monthly benefit will be.

4. Coordinate Other Retirement Savings

If you’re nearing retirement and haven’t maximized your Social Security earnings, consider contributing to another retirement plan. Sometimes, it’s better to focus on retirement financing options other than Social Security. 

Social Security should not be your sole income source. It isn’t designed for that. Consider how other retirement savings, like pensions, IRAs, and 401(k)s will help you pad out your retirement savings. 

Factor in your desired lifestyle, projected expenses, and other income sources you may have in retirement. This information should give you the total amount you need for a secure retirement using Social Security – but not relying on it completely. 

5. Spousal Benefits

You should consider your spouse, too. When each spouse retires and claims benefits, it can impact the household income. Use the online SSA tool we linked to above, which can help you play with different scenarios and make a decision. 

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