04/20/2011 12:10 pm ET Updated Jun 20, 2011

Social Security Looms for Baby Boomers

Talk about a stampede: The first wave of Baby Boomers begins turning 65 in 2011, which means they'll soon be tapping Social Security retirement benefits, if they haven't already. If you're a Boomer and haven't yet investigated how this program works, this may be a good time to learn the ropes.

Here are a few highlights:

Eligibility. When you work and pay Social Security taxes, you earn up to four "credits" per year based on net income. In 2011, you must earn at least $1,120 to earn one credit. People typically must accumulate at least 40 credits over their lifetime to qualify for a retirement benefit; however, those who haven't earned sufficient credits sometimes qualify for a benefit based on their spouse's work record.

Benefit calculations.
Your retirement benefit is calculated based on earnings during 40 years of work. The five lowest-earning years are dropped from the equation; plus, each year not worked counts as a zero. Social Security "full retirement age" increases gradually from 65 for those born before 1938 to 67 for those born after 1959. To calculate your own full retirement age, use this calculator from Social Security.

If you meet eligibility requirements, you may begin drawing reduced benefits beginning the first full month after you reach age 62; however, doing so may reduce your benefit by up to 30 percent, depending on your birth year. The percentage reduction gradually lessens the closer you approach full retirement age.

Alternatively, if you postpone collecting your benefit until after reaching full retirement age, your benefit will increase by 7 to 8 percent per year, up to age 70. Many people -- particularly those with long life expectancies -- postpone their benefits as long as possible, to ensure a larger lifetime monthly benefit. Plus, because very few investments, including 401(k) plans, yield a guaranteed 7 to 8 percent rate of return, many retirees prefer to tap their 401(k) first and postpone collecting Social Security as long as possible.

Spousal benefits.
If you're married and your earned benefit is less than 50 percent of your spouse's, you will be eligible for a benefit typically equal to half of his or hers.

Spousal benefits also are available if you're divorced, provided: your marriage lasted at least 10 years; you remained unmarried before age 60 (or that marriage also ended); and you're at least 62. If you remarried after age 60 (or 50, if disabled), you can still collect benefits based on your former spouse's record. If you're over 62, you may instead opt for benefits based on you new spouse's record if they are higher.

Survivor benefits. If your spouse dies and was benefits-eligible, you and your children may be eligible for survivor benefits. Benefit amounts vary depending on age, disability status and several other factors. Read Social Security's Survivors Planner for details.

Estimating your benefit. One helpful tool to estimate your potential benefits is the annual Social Security Statement mailed each year about three months before your birthday. Check this statement for any errors to your earnings record since that could impact future benefits. You may also use Social Security's Plan Your Retirement tools to estimate your retirement benefit under different earnings, age and life-expectancy scenarios.

Working and Social Security. Be aware that if you begin collecting Social Security before full retirement age yet continue to work, your benefit may be reduced. If you earn over $14,160 in 2011, you will lose one dollar of Social Security benefits for every two dollars you earn over that amount. (Note: Investment income doesn't count.)

However, if you're slated to reach full retirement age in 2011, the benefit reduction formula changes slightly: Instead of losing one dollar for every two dollars in benefits over $14,160, one dollar will be deducted from your benefits for each three dollars you earn above $37,680 until the month you reach full retirement age. After that, there is no further reduction.

Thus, if you think you'll need to continue working to make ends meet, it might be wiser to hold off on collecting Social Security until you reach full retirement age. Be aware, though, that these benefit reductions are not completely lost: Your Social Security benefit will be increased upon reaching full retirement age to account for benefits withheld due to earlier earnings.

Other tax implications. Even though Social Security benefits aren't taxed by many states, they are considered taxable income by the federal government. So, depending on your "combined income" (adjusted gross income plus nontaxable interest earned plus half of your Social Security benefits), you may owe federal income tax on a portion of your benefit.

The formula is complicated, but basically:
  • Single people whose combined income is less than $25,000 are not taxed on their Social Security benefit.
  • For combined income between $25,000 and $34,000, up to 50 percent of your benefit may be taxed.
  • For combined income over $34,000, up to 85 percent of your benefit may be taxable.
  • For married people filing jointly: benefits are not taxable for combined income below $32,000; benefits between $34,000 and $44,000 are up to 50 percent taxable; and benefits over $44,000 are up to 85 percent taxable.
  • For more details, read the IRS' Tax Topic 423 and Publication 915.

One last point about taxes and Social Security: Any wages you earn after you've begun to collect Social Security retirement benefits is subject to Social Security and Medicare taxes, regardless of your age. To learn more, read How Work Affects Your Benefits at Social Security's website.

You need to apply for Social Security at least three months before you want to start receiving benefits, so start exploring your options now.

This article is intended to provide general information and should not be considered legal, tax or financial advice. It's always a good idea to consult a legal, tax or financial advisor for specific information on how certain laws apply to you and about your individual financial situation.

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