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Personal Finance

3 common questions about Social Security, answered

Social Security is a simple program, but there are many misconceptions about how it actually works.

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For many retired seniors, Social Security benefits are an essential source of income. With fewer employers offering pensions, these benefits — along with 401(k)s and IRAs — have become important retirement income sources for many Americans. According to the Center on Budget and Policy Priorities, they comprise 90% or more of income for nearly one quarter of retirees.

Since the average Social Security monthly benefit for workers in the U.S. is only $1,666.49 as of April 2022, most people will also need to invest for retirement on their own, likely through an employer-sponsored 401(k) or an IRA. Select ranked Charles Schwab, Fidelity Investments, Vanguard, Betterment and E*TRADE as having the best IRAs.

When it comes to Social Security, understanding how the program works can help you figure out how to maximize your benefits and be better prepared for retirement. Here, Select tackles three commonly asked questions about it.

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What happens to the money I paid into the Social Security system?

A common misconception about Social Security is how the program actually works.

First off, Social Security is funded through payroll tax deductions, which are paid by both employers and employees — they're taken directly out of your paycheck — and put toward social insurance programs such as Social Security, Medicare, Workers' Compensation, Disability Insurance and Unemployment Insurance. 

In 2022, the Social Security payroll tax rate was 6.2% for employers and 6.2% for employees, or 12.4% in total, and applies to up to $147,000 worth of an individual's income.

Current workers are funding the benefits for current retirees, so the money that's being deducted from your paycheck isn't going to a specific Social Security account meant for you. Instead, that money is being used to fund the benefits of those who are currently retired and their families, as well as people with disabilities and their families. 

According to Suzanne Shu, professor of marketing at Cornell University, this misunderstanding about how Social Security works often leads people to collect their benefits earlier than they should.

By thinking about Social Security like it's a 401(k) or an individual retirement account, people tend to have a stronger sense of ownership over their benefits, which leads them to collect early or before full retirement age, explains Shu. Doing so means missing out on a higher monthly benefit, and you should have a clear understanding of how Social Security benefits work before you decide to collect them.

In order to earn retirement benefits, you must work at least 10 years; the monthly benefit you'll receive is calculated by a formula that uses a worker's 35 highest-earning years. While retirees can start collecting at 62, they'll receive reduced benefits unless they wait until their full retirement age.

Full retirement age ranges between 66 and 67, depending on when you were born. For every year beyond your full retirement age that you wait to collect (until the age of 70), your benefits will increase by 8%.

Of course, not everyone benefits from choosing to delay this collection, so it's also a good idea to take other factors into account as well, such as your spouse, health status, other family members or additional sources of retirement income.

Do undocumented immigrants receive Social Security?

Undocumented immigrants are not legally permitted to receive Social Security benefits and few actually do.

Generally, when you apply for a job, you're required to provide your Social Security number so employers and employees can pay the payroll taxes that are used to fund the program. Undocumented immigrants, who don't have an Social Security number, may choose to use an Individual Taxpayer Identification Number, or an ITIN, or may even use a fake Social Security number to pay payroll taxes.

Even though undocumented immigrants are legally required to pay taxes, those who use an ITIN to do so cannot receive Social Security retirement benefits. Sometimes undocumented immigrants do receive retirement benefits by using a Social Security number that belongs to someone else, a fake one or one held over from an overstayed visa. However, even those who use a fake Social Security number may not receive retirement benefits since they don't have tax forms that match up with an existing Social Security number.

A 2013 report by the Social Security Administration found that $1 billion worth of retirement benefits were paid out to undocumented immigrants in 2010. However, undocumented immigrants paid significantly more money into the Social Security system than they receive in benefits, contributing a whopping $13 billion in payroll taxes.

"Thus, we estimate that earnings by unauthorized immigrants result in a net positive effect on Social Security financial status generally, and that this effect contributed roughly $12 billion to the cash flow of the program for 2010," writes Stephen Goss, chief actuary of the Social Security Administration.

In other words, undocumented immigrants are not legally allowed to collect Social Security benefits and rarely do. Undocumented immigrants help fund Social Security because their contributions provide extra cash flow to the system.

Does Social Security cost the government a lot of money to operate?

Surprisingly, the answer is no. It turns out Social Security is a relatively cheap social insurance program for the federal government to administer. This is mostly because it is not a means-tested program, which would exclude individuals and families based on income. Since participation in Social Security is universal, there are lower operating costs.

In 2021, administrative costs accounted for only 0.6% of disability and old age-survivor benefits doled out, while administrative costs for just the old-age survivors trust fund were 0.4%. That means, according to the Social Security Administration, for every one dollar people contribute to Social Security, less than one cent actually goes toward operating expenses.

However, there is a fair amount of "improper payments" made by the Social Security Administration, which includes making accidental payments to the deceased all the way to willful fraud. The Social Security Administration estimates it made $7.9 billion in improper payments in the 2019 fiscal year.

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Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.
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