Social Security and Medicare are, for many people, the single greatest asset they have in retirement.

What are Social Security and Medicare?

While you may not have to think about drawing from Social Security for many years, it’s smart to understand why you pay taxes for these programs, what you are entitled to when you retire and how Social Security and Medicare fit into you total retirement savings plan.

Social Security

Social Security is program set up by the U.S. federal government that provides retirement income, disability income and other financial benefits to those who qualify. The program is funded by taxes on earned (job) income. When you are a full-time employee, Social Security and Medicare taxes — also called the Federal Insurance Contributions Act (FICA) tax — are withheld from each paycheck. When you are self-employed, you pay these taxes through the self-employment tax.

• See also: Deductions, exemptions and credits; Withholding and estimated taxes; Self-employment

When you retire or become disabled, you will be eligible for Social Security benefits if you paid at least 40 quarters of at least the minimum Social Security taxes at any point during your lifetime. The amount of your benefits is based on your average earnings over your 30 highest-earning years. When you paid these taxes as a full-time employee, your employer or employers matched the contributions that were withheld from your paychecks.

Medicare

Medicare is a health insurance provision added to Social Security program. This basic health and medical insurance is for people age 65 or older, younger than age 65 with certain disabilities and any age with permanent kidney failure, also called end-stage renal disease or failure. To qualify for Medicare, you must be legal citizen and have been in the United States for at least five years.

Medicare is operated by the Social Security Administration and is funded by pre-tax employee payroll deductions. Like other insurance plans, there are maximum benefits, exclusions and other requirements. You pay monthly premiums and are sometimes responsible for out of pocket deductibles and co-payments.

• See also: Health insurance

Health insurance protects retirees from the risk of major financial setbacks in the event of an unexpected medical event — and Medicare is a kind of this insurance. For retired persons who don’t have access to private health insurance plans, Medicare is an important benefit. Medicare does not cover all medical costs, so beneficiaries can purchase additional supplemental insurance through local providers, commonly called Medigap, to help pay for costs that Medicare does not cover. Medicare also can help with the costs of long-term care, either at home or in a facility.

• See also: Caregiving, Other insurance

Why do I need Social Security and Medicare?

There are four primary reasons you should care about Social Security and Medicare:

• You contribute taxes toward them every year you work.

• They are federal benefits that you will be able to collect when you retire.

• Social Security is the biggest retirement asset most Americans receive today.

• Medicare will reduce your medical costs by covering most of your health expenses, minus co-pays and deductibles.

Though it is a substantial benefit, Social Security alone is not enough to cover the cost of retirement for most people. It should not be your sole retirement plan. You should supplement Social Security by saving at least 10% of your income each year in a work-sponsored retirement plan or an individual retirement arrangement (IRA). If you wait until your 30s to save, you should increase your annual savings to 15%. The longer you wait, the higher a percentage you should save.

• See also: IRAs; 401(k)s, 403(b)s and 457(b) Thrift Savings Plan

Social Security is available to all who pay into it. Despite what you might hear or read in the news, Social Security is backed by the full faith and credit of the U.S. government — it’s not likely to be going away.

If you are a citizen and don’t already have a Social Security number or card, or if you have lost it, you may get it replaced without charge. Search “Social Security card” on the Social Security Administration (SSA) website to download forms that you can complete and mail:

• Social Security Administration: www.ssa.gov

If you are a new parent, make sure to register your child or children with the SSA and get them their cards.

How do I pay Social Security tax?

Because workers in the United States must pay a Social Security tax from wages earned, all individuals must have a Social Security number. Your Social Security number is your permanent work identification number.

When you start a new job, your employer will require the you provide your Social Security number by filling out a Form W-4.

Employers withhold Social Security taxes from your pay and contribute matching amounts. When you become eligible to use and claim these benefits, benefits are paid to you monthly, based on how much you’ve paid into Social Security.

• See also: Withholding and estimated taxes

The amount of Social Security benefits you will receive will depend on the amount of contributions you make. Social Security tax is sometimes abbreviated on your pay stub as SST, SS or FICA. Medicare tax is abbreviated as MWT, MT or Med. The government requires that 6.2% of your pay be withheld from your paychecks for Social Security tax and 1.45% withheld for Medicare tax. Your employer matches these amounts, though you don’t see that on your paycheck or pay stub.

Unlike other workers, self-employed people are both employer and employee, so they must pay both the employee and matching employer contributions to Social Security and Medicare. 

• See also: Income tax returns, Self-employment

So for Social Security tax, self-employed individuals pay 12.4% of gross income. For Medicare tax, they pay 2.9%. The total of 15.3% is called the self-employment tax.

• See also: Self-employment

Remember, a portion of Social Security benefits can be considered taxable income if your total income from all sources during retirement exceeds amounts set each year. In addition, several states currently tax Social Security benefits as income.

When do you receive Social Security and Medicare benefits?

You can begin to use Medicare benefits when you turn 65. When you’re ready to enroll, you can do so on the Medicare website — which will ask you to complete an eligibility quiz and help you get started.

• Medicare: www.medicare.gov/default.aspx

If you contributed taxes to Social Security, can begin receiving benefits at age 62, but your benefit will be greater if you wait until your full retirement age (currently 65, but rising to 67) or later. Delaying Social Security benefits can result in a higher benefit check for the rest of your life. If you were married for more than 10 years, you may be entitled to receive benefits based on your spouse’s income. You qualify for benefits based on your spouse’s work history.

Because you have Social Security taxes withheld from your paycheck, you are entitled to disability payments from Social Security in the event you become disabled and cannot work. To qualify, you will have to prove the extent of your disability, fill out form and have medical exams, as required by the SSA. Workers are considered disabled if they have a physical or mental condition that prevents them from doing any gainful work, and the condition is expected to last for at least 12 months or result in death. Your benefits are determined by the amount of your pay and by the number of years you have been covered under Social Security.

Every few years, you should also check to see that your earnings have properly credited to your account. Each year, you should receive a statement that shows the record of income on which you’ve paid Social Security taxes and an estimate of benefits you will receive at retirement. The SSA provides a form either by mail or online. Visit the SSA website and search “Social Security statement.” If you find any errors on your statement, report them right away.

• Social Security Administration (SSA): www.ssa.gov

Words to know

Unsure about something you read? Many of the financial terms you came across in this article are defined in our financial glossary. A-Z Glossary

Links we like

Here are a couple online features you might find useful:

• Social Security Administration: www.ssa.gov

• Medicare: www.medicare.gov

• AARP Social Security: www.aarp.org/work/social-security