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The Self-Employed Worker's Guide to Social Security

Kailey Fralick, The Motley Fool

Self-employed workers face some unique financial challenges, including extra hoops to jump through at tax time and no employer to match their retirement fund contributions. The rules surrounding Social Security are also a little different for these workers, and it's crucial that you understand them so you don't accidentally cost yourself benefits. Here's a look at how being self-employed impacts how much you pay into Social Security and how much you get out.

Paying Social Security tax

Every worker pays some Social Security tax, but for most people, the 12.4% tax is split evenly between employee and employer. The same goes with the 2.9% Medicare tax. But when you're self-employed, you're both employee and employer, so you have to pay the full amount. Because you don't have regular paychecks the government can withhold money from, you need to set aside this money on your own in a savings account and pay it as part of your quarterly estimated taxes.

Social Security card with calculator and statement.

Image source: Getty Images.

The good news is, you get to write off half of what you pay in Social Security and Medicare taxes, which reduces the amount of income tax you owe. So if you earned $50,000 this year and 15.3%, or $7,650, was for Social Security and Medicare, you could write off half of this -- $3,825 -- so you'd only pay income tax on the remaining $46,175. You could reduce this amount further with additional deductions and possibly move yourself into a lower income tax bracket.

Qualifying for Social Security

Social Security qualification requirements are the same for self-employed and traditional workers. You must earn 40 credits. You receive one credit for every $1,360 you earn in 2019 with a maximum of four credits per year. This means you must work 10 years in order to qualify, though these 10 years do not have to be consecutive. The dollar amount required to earn one credit may change from year to year.

Calculating Social Security benefits

Your Social Security benefit is based on your average monthly income during your 35 highest-earning years, adjusted for inflation. If you haven't worked for 35 years, your calculation will include zeros that bring down your average. The Social Security Administration (SSA) keeps track of your annual earnings, and you can view them by creating a my Social Security account. For traditional workers, the income listed on your W-2 is the amount that the SSA records, but it's more complicated for the self-employed.

Independent workers can claim tax deductions for things like office supplies, business travel, a home office, or any other work-related expense. All of these reduce your taxable income this year, saving you money in income taxes. But the catch is that the SSA looks at your taxable income for the year when calculating your Social Security benefits. So by taking advantage of the tax breaks today, you could be reducing the amount of Social Security benefits you're entitled to in the future.

This raises the question of whether it's smarter to take the tax deductions now or skip them and potentially increase your Social Security checks later. There isn't a clear-cut answer, but in most cases, you're probably better off taking the deductions this year. It's difficult to predict how much more you'll actually get from Social Security by reporting a higher taxable income this year, especially with the future of Social Security so uncertain right now. You're probably better off taking the sure money-saving bet with the tax deductions than gambling on a possible future benefit with Social Security.

Claiming Social Security benefits

Claiming Social Security benefits works the same way for all workers. You become eligible at 62, but you won't receive your full scheduled benefit per check unless you wait until your full retirement age -- 66 or 67, depending on your birth year. If you start early, you'll receive a reduced amount per check to account for the extra months you're receiving benefits. Starting at 62 will get you 70% or 75% of your scheduled benefit per check, depending on your full retirement age. You can also delay benefits past your full retirement age, and your checks will increase until you reach the maximum benefit at 70. This is 124% or 132% of your scheduled benefit per check.

There isn't an easy answer to when you should begin claiming Social Security. If you don't expect to live long, starting earlier will probably get you more benefits, but if you believe you'll live into your mid-80s or 90s, delaying benefits can get you larger checks that will cover more of your living expenses in retirement. Ultimately, it's up to you to decide when you want to start taking benefits. Think about how long you expect your retirement to last and which age will give you the most benefits overall. You can estimate your benefits at 62, full retirement age, and 70 in your my Social Security account.

Social Security is there for traditional and self-employed workers alike, but self-employed workers have to face some extra hurdles. By understanding the differences in how Social Security is taxed and how benefits are calculated, you can avoid running into any issues at tax time or when you file for Social Security benefits.

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