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Most retirees depend on multiple sources of income at the time of retirement. The two most common sources of income are social security and pensions. If we look at retirement versus Social Security income, we find significant differences. Retirees should understand the main differences between the two programs. They are funded, structured and taxed differently. If you are planning to retire, be sure to use the information of a financial advisor.

Pensions defined

Approximately 44% of Americans are currently covered through their companies with a defined benefit plan. Defined benefit plans have been shut down at many companies and today only 4% still offer them. However, they still provide benefits to Americans who are still living and retiring on these plans. They have largely been replaced by defined contribution plans such as 401(k) and IRAs.

Pensions are for retirement plans, as opposed to Social Security. Their goal is to provide their pensioners with an allowance sufficient to live on. Of course, the allowance depends on their age, length of service and wages during their employment. There may be a requirement for empowerment. In other words, you may have to stay with the company for some predetermined period of time, sometimes five years, in order to qualify. Social Security has no eligibility requirements. Spouses can receive a partial payment from the pension if the pensioner passes away, but, as a rule, minor children or dependent parents do not receive benefits, as is the case with the Social Security program.

You can usually start receiving retirement benefits if you retire at age 55. You must wait until you are 62 to start receiving Social Security benefits. In addition, there is no defined benefit disability insurance program, as is the case with the Social Security program. Social Security pays a small death benefit, but pensions don’t have that feature.

Some defined benefit pension funds will distribute your funds as a lump sum. You can choose whether to take a lump sum payment or opt for monthly benefit payments. You don’t have this option with Social Security.

Definition of social security

Social security cards

Social security cards

The Social Security program is not a pension and was never intended to be a pension. This is a social security program administered by the US federal government. It has always been considered an additional retirement income for the workers it covers, although we know there are many Americans who live almost exclusively on their Social Security checks. The federal government has created two social security trust funds. Retirement Social Security benefits come from the Old Age and Survivors Fund. This fund also pays a survivor’s and spouse’s benefit, as well as a retirement benefit.

A Social Security pension is similar to a pension in many ways. It pays a monthly retirement benefit in the same way as a defined benefit pension plan. Individuals and companies contribute to this system through a payroll tax. The amount you pay to Social Security is shown on your FICA, Federal Income Contribution Act, receipt. Employees pay 6.2% of their wages to the social security fund and their company pays 6.2% for them. The self-employed pay all 12.4%.

There are three sources of social security funding. The first is the payroll tax. Social Security is also funded by interest on excess contributions held by the US Treasury and, thirdly, taxes paid on benefits by current beneficiaries. The payroll tax finances most of the Social Security fund.

The amount of Social Security benefits a retiree receives depends on the number of years they worked and the total wages they received. It also depends on the age of the worker when they start receiving benefits. If you retire in your retirement year, you will receive full Social Security benefits. But if you retire between age 62 and your retirement year, your benefits are reduced based on your individual situation.

Social Security also pays a small survivor’s benefit when a retiree dies. A widow’s pension or spousal allowance may be paid, but this depends on the individual situation.

Current workers who pay into the social security fund fund benefits for future workers. Social Security is not a right. It’s a pay-as-you-go system.

The second part of the social security program is the disability insurance benefit. If a person is disabled and has sufficient credit, they may be eligible for disability benefits instead of retirement benefits.

Pensions and Social Security: Key Differences

elderly muslim couple

elderly muslim couple

The Social Security program is not a retirement plan. This is a social insurance plan designed to supplement a retiree’s pension and savings. If an employee has paid into the Social Security fund, they may start receiving benefits at retirement age. The retirement age for social security is at least 62 years. A defined benefit pension is usually 55 years. Sometimes you may receive a lump sum or monthly pension. You cannot receive Social Security at a time.

There is an eligibility requirement for many pension plans, but not for Social Security. In the event of the death of a pensioner, the spouse may receive a reduced benefit and a small survivor’s benefit. There are no survivor benefits in the pension plan. Social Security may provide survivor benefits to dependent parents and dependent children.

Social Security is funded primarily by the payroll tax that most Americans pay. Retirement plans are privately funded by company and employee funds. Social Security has a disability income program, while pension funds do not.

Social Security recipients are subject to a differentiated income tax based on their income. Only a portion of Social Security benefits is taxable. All retirement income is taxed at your regular tax rate, although it may not be subject to state tax. If you work after you start receiving Social Security, most of your Social Security may be taxed at a higher rate. The taxation of your pension does not depend on whether you work or not.

Taxation of pension and Social Security income may differ. Thirty-seven states do not tax Social Security income. If the only retirement benefit you receive is Social Security, you probably won’t have to pay any taxes on it at all. As an individual, if your income is between $25,000 and $34,000, you may have to pay tax on 50% of your income and 85% of your income if it is over $34,000. For a married couple, that income threshold is $44,000. Retirement income is simply taxed at the normal tax rate.

You are not required to pay Social Security tax in excess of the base wage cap, which is $142,800 in 2021. However, you continue to pay tax on your retirement income.

bottom line

Social security and retirement benefits should be part of the overall retirement strategy. They are similar in some ways, but have important key differences, especially in how they are financed, structured and taxed. Think of them as separate parts of your overall retirement portfolio strategy.

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The post “Pension vs. Social Security: Key Differences” first appeared on the SmartAsset Blog.

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