Social Security Benefits

Benefit payments received by to qualified retirees and people who are disabled, including their spouses and children

What are Social Security Benefits?

Social Security benefits are benefit payments that are made to qualified retirees and people who are disabled, including their spouses and children.

Social Security Benefits

In the United States, Social Security is formally referred to as Old-Age, Survivors, and Disability Insurance (OASDI). OASDI is a program that provides comprehensive federal benefits to replace income for older workers and their spouses or those whose spouses have died or have become disabled.

In certain conditions, it also provides benefit payments to children and beneficiaries. Other countries may adopt their own form of Social Security benefits that are meant to transfer wealth from the younger working generation to the older, retired generation. For example, Canada offers the Canada Pension Plan (CPP) and Old Age Security (OAS) for retirees.

History of the Social Security Act

The original Social Security Act was signed into law in 1935. It was a law that was created to transfer wealth from younger people who are working to disabled and retired people who cannot work. The legislation was passed in response to the period during the Great Depression, where social and economic changes were occurring rapidly.

Before the Social Security Act, many senior citizens would fall into poverty as they became older and could not work to support themselves anymore. Furthermore, disabled people were disadvantaged in society by not being able to perform the same jobs as others.

Social Security benefits are determined by criteria that are set by the Social Security Administration (SSA). The SSA is a U.S. government agency that administers and oversees the social programs covered under the Social Security Act.

How Social Security Benefits Work

Generally, Social Security benefits work by taking payroll taxes from the earned income of employees or self-employed individuals. The payroll taxes are collected by the Internal Revenue Service (IRS). The IRS is a government organization responsible for collecting taxes on behalf of the U.S government. The Canadian counterpart is known as Canada Revenue Agency (CRA).

Individuals can qualify for Social Security benefits by paying into the program while they are working. Full benefits can be redeemed when an individual retires if they’ve accumulated enough working quarters or “credits” and paid enough into the program over their working years.

The SSA will keep track of earnings over the individual’s career, and will index each year’s total earned income, using the 35 highest-earning years for an individual to determine their average indexed monthly earnings (AIME). AIME is subsequently used to calculate the primary insurance amount (PIA).

The PIA represents the monthly amount that can be collected when the individual reaches retirement age. The earliest they can begin collecting Social Security benefits is at the age of 62. However, the benefits are reduced if the individual chooses to receive the benefits earlier. Conversely, if the individual decides to wait until later, for example, the age of 70, they will be compensated with a higher PIA for the remainder of their life.

Social Security Trust Fund

The taxes collected from working people are funneled into a trust known as the Social Security Trust Fund, which holds two separate funds:

1. Old-Age and Survivors Insurance Trust Fund

2. Disability Insurance Trust Fund

The Social Security Trust Fund holds all the contributions made by workers and employers in excess of what is required to make scheduled Social Security payments to retired and disabled people. The funds are invested in government securities like Treasury bonds in order to make risk-free investment income.

Social Security Trust Fund

Problems with Social Security Programs

Several countries, including the United States, are running into funding problems with their Social Security programs. The demographic issue is that as populations age, there are more retirees and less working people to support the Social Security funds. In fact, it is predicted that many Social Security programs will run out of money within the next few decades unless structural changes are made.

Some ideas to mitigate the problem are to raise the retirement age, increase taxes, reduce spending or benefits paid, or borrow more. Within the U.S., the SSA produces an annual report that provides the projected financial health of the trust funds for transparency.

Related Readings

CFI offers the Commercial Banking & Credit Analyst (CBCA)™ certification program for those looking to take their careers to the next level. To keep learning and developing your knowledge base, please explore the additional relevant resources below:

Financial Analyst Certification

Become a certified Financial Modeling and Valuation Analyst (FMVA)® by completing CFI’s online financial modeling classes and training program!

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