Investopedia

Fact checked by Vikki Velasquez

Benjamin Franklin is credited with saying that nothing is certain in this world but death and taxes. That was back in 1789 and it still holds in the U.S. more than 230 years later.

U.S. taxation has thrived and faltered from implementing the first income tax to various attempts at tax reform. Some changes have been more taxpayer-friendly than others. Here’s a closer look at the history of the U.S. tax system.

Key Takeaways

• The need to finance the Civil War created one of the first versions of a federal income tax in 1862.
• The U.S. income tax was officially born on Feb. 3, 1913, when Congress ratified the 16th amendment to the U.S. Constitution.
• Less than 1% of Americans had to pay the tax in its earliest days.
• Major tax reforms have been ongoing for decades.
• Some consumer dollars can effectively be taxed twice when excise taxes come into play.

Early History of U.S. Taxation

Benjamin Franklin spoke on taxation well before the U.S. officially launched an income tax. Before the Civil War, the nation derived most of its income from banknotes. The tax rate imposed on individuals was minimal, from 1% to 1.5%. American citizens received virtually nothing in exchange. Civil services and protections on the frontier and coasts were minimal.

The need to finance the Civil War prompted some changes, effectively creating the first version of an income tax in 1862. President Lincoln signed a law that created the Commissioner of Internal Revenue and imposed an income tax on individuals ranging from rates of 3% on incomes of $600 to $10,000 and 5% on incomes over $10,000.

This version of the tax was repealed 10 years later but it came back to life in 1894 with the Wilson Tariff Act. The act levied a 2% tax on incomes over $4,000. The U.S. Supreme Court ruled one year later that the tax was unconstitutional.

“Through the Civil War and beyond, income tax was tried, disputed in the courts, and finally resolved with the passage of the 16th Amendment in 1913, constitutionally establishing income taxes,” according to Thomas J. Cryan, an attorney and the author of Disrupting Taxes.

Birth of the Federal Income Tax

The federal income tax as we know it was officially born on Feb. 3, 1913, when Congress ratified the 16th Amendment to the U.S. Constitution after an on-again-off-again start that lasted decades.

The amendment read, “Congress shall have the power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several states, and regard to any census or enumeration.”

However, less than 1% of Americans had to pay the tax in the first days after its inception, thanks to the amendment’s provisions for numerous taxpayer-friendly deductions and exemptions. The rate was only 1% of net income at that point. Congress later added a 6% rate for incomes of more than $500,000.

Numerous tweaks and add-ons occurred in the 1940s. The Revenue Act of 1942 increased tax rates and the number of citizens who had to pay it. The Current Tax Payment Act passed a year later, heralding the beginning of the tax withholding process by employers. Standard deductions were created in 1944 with the passage of the Individual Income Tax Act.

“The withholding system was implemented simply because the collection was easy,” says Cryan, “not because it was the soundest, most equitable, or most efficient tax system.”

However, the Internal Revenue Service attempted to make the tax process more efficient over the years. The first toll-free telephone line was introduced in 1965. Electronic filing began in 1986 although it was limited at first. Taxpayers who owed money were able to electronically file their returns beginning in 1992.

Tax Reforms and Major Changes

Reforms have been ongoing. The federal government has incrementally made some major changes to the tax system.

The Alternative Minimum Tax (AMT)

Annette Nellen, a certified public accountant (CPA) and attorney who serves as a professor and the director of the MST Program at San Jose State University cites the alternative minimum tax (AMT) as a major adjustment. The AMT was created in 1969 because “it was found that a few hundred high-income individuals were able to use a combination of exclusions, deductions, and credits to pay little or no income tax,” Nellen says.

The Tax Reform Act (TRA)

Nellen also mentions the Tax Reform Act that was launched in 1986. She says it broadened the AMT so more high-income individuals would be subject to it.

“The Tax Reform Act of 1986 made numerous changes to the tax law including taxing ordinary and capital gains income at the same rate and there were only two brackets (15% and 28%). It also added passive activity loss limitation rules that shut down a tax shelter industry that many middle- to high-income individuals had been using to minimize their taxes.”

The American Taxpayer Relief Act (ATRA)

The American Taxpayer Relief Act (ATRA) restored the top income tax rate to 39.6% in 2012 after it was cut to 35% by President George W. Bush’s tax cuts in 2001 and 2003.

The Tax Cuts and Jobs Act (TCJA)

President Trump signed the Tax Cuts and Jobs Act (TCJA) into law in 2017 and introduced some sweeping changes to the U.S. tax system. They included significantly increasing standard deductions and reducing personal income tax rates. The 35% top rate created by ATRA had increased back to 39.6% but the TCJA dropped it to 37%. The 15%, 25%, 28%, and 33% rates imposed on lower-income earners were cut to 12%, 22%, 24%, and 32% respectively.

The cap on the itemized deduction for interest paid on home mortgages was reduced, however, and a reduced limit was imposed on the state and local tax (SALT) itemized deduction as well. Some miscellaneous itemized deductions were eliminated entirely.

Important

The TCJA expires at the end of 2025 unless Congress takes steps to renew some or all of its provisions.  

The Inflation Reduction Act

The Inflation Reduction Act (IRA) came along in 2022. According to Nellen, “The IRA included numerous new and modified energy credits for individuals and businesses. It’s possible that some of these credits may be repealed or downsized as part of any extension of expiring provisions of the TCJA or new tax breaks such as not imposing income tax on tips or overtime pay of employees.”

Excise and “Sin” Taxes

Taxation doesn’t begin and end with those imposed on income and earnings. Excise taxes, often called “sin” taxes, can take a hefty bite out of taxpayers’ bank accounts as well. These taxes are imposed on the sale of specific products and services.

They’re generally paid by retailers, producers, and wholesalers but these entities pass them down to the consumers who purchase them. Commonly affected purchases include alcohol, tobacco, health insurance, and gasoline. The excise tax on cigarettes averages about $1 a pack. Beer and wine are typically taxed at a lower rate than distilled spirits.

“The key purpose of excise taxes on alcohol and tobacco is to tax undesired behavior, particularly the purchase of cigarettes by young people,” Nellen says, “and to generate a small amount of revenue. There are several federal excise taxes, but the ones on alcohol, tobacco, and gasoline are best known. Excise taxes are a small part of government tax collections, representing less than 2% of total federal tax revenues. For 2023, excise taxes were $75.8 billion, representing 1.7% of total tax collections of $4.4 trillion.”

Cryan agrees about the deterrent nature of these taxes. “Excise taxes on alcohol and tobacco traditionally lean to increased prices at the time of the retail sale. This price increase will often reduce consumption which can have the follow-along effect of a decrease in consumption related to less health harms.”

Numerous consumers continue to spend that extra dollar on a pack of cigarettes, but it’s a safe guess that their wallets will feel the effect because they also have to deal with income tax on that money.

The Bottom Line

Taxation in the U.S. has always been a shapeshifting beast and this can be exacerbated by all its various applications from income to that modest purchase you just made at your favorite liquor store. Tax laws don’t just change every five to ten years. They can occur annually just as you’re getting used to the last ones that were imposed.

They’re inevitable, however, just as Benjamin Franklin asserted. Taxpayers can benefit from keeping a watchful eye on the ever-evolving changes and checking in with a tax professional when changes are looming so they can best prepare for the impact whether it be affirmative or negative.

Fact checked by Vikki Velasquez

If your 401(k) isn’t performing as well as you wish, there are things you can do about it. First, determine the reasons for the sluggish performance, and then make some changes toward a more profitable 401(k) plan.

Here are five reasons why a 401(k) plan may be underperforming.

Key Takeways

• To rev up an underperforming 401(k), swap out a target date fund with a large-cap growth fund.
• Exchange 401(k) investments with high fees for cheaper investments that meet your financial aims.
• Instead of chasing the highest performance, choose an investment that meets your financial needs and stick with it for the long term.
• Switch more conservative, lower-performing investments to a more aggressive stock fund.
• Contribute enough in your 401(k) to qualify for a matching contribution from your employer.

Choosing a Target Date Fund

Target date funds make investing a breeze, but they may not give you the type of return you are looking for in your 401(k).

“This is a fund that tries to get near your 65th birthday as a retirement year; e.g., 2030, 2035 … 2060, 2065. They start off with a higher allocation to stocks vs. bonds the younger you are and then progress to get more conservative by having more in bonds than stocks as you approach retirement,” says Jarrod Sandra, certified financial planner at Chisholm Wealth Management.

If you don’t choose another investment in a 401(k) plan, you may be automatically invested in a target date fund.

“Target date funds are now the leading default investment for employees within 401(k) plans, and most target date funds are underperforming the market because of their asset allocation,” says John Bovard, a certified financial planner at Incline Wealth Advisors. “401(k) participants can log in to their account and rebalance into an S&P 500 fund or some other large-cap growth fund to become more aggressive.”

You don’t need to be wealthy to benefit from having a financial guru on your side. Consider hiring a financial advisor to help you create a comprehensive plan covering retirement, taxes, estate planning, insurance needs, and major life transitions.

High Investment Fees

If you are paying large fees on your 401(k) investments, this may cause your 401(k) to underperform. Evaluate 401(k) fees by reviewing your Participant Fee Disclosure document.

“Check the list of fund options in your 401(k), and you should be able to see the expense ratio for each fund,” says Carla Adams, founder and financial planner at Ametrine Wealth.

If the fees you are paying are higher than you like, choose a more cost-effective investment option that is still in line with your financial goals. Look for investments with low expense ratios.

“Each 401(k) plan has its own option of investments to choose from, so you may not have access to super-low-cost funds, but ideally you should be investing in only funds with expense ratios of under 0.20%,” Adams says.

Performance Chasing

If you keep moving around your 401(k) investments in search of the highest returns, you may end up with an underperforming 401(k).

“Rather than choosing funds off of recent performance, come up with a long-term strategy of which fund you plan to invest in and stick with it for the long run,” Adams says.

If you come across a poorly performing fund in a 401(k), report this fund to the plan administrator.

“401(k) administrators also have an obligation to regularly review the funds they’re offering in the plan, so if any funds are consistently underperforming, the plan may end up removing the fund and replacing it with a better option,” Adams says.

Conservative Investments

If you choose to invest in more conservative assets such as bonds, you can expect a lower return on your investments.

“How is your 401(k) allocated between stocks and bonds? If you are heavily invested in bonds, then you should expect your 401(k) to underperform the stock market more often than not, so comparing your performance to the S&P 500 is not appropriate,” Adams says.

If your investments are too conservative for your financial goals, you can change them to more aggressive options.

“This is an opportunity to shift your portfolio more into stock funds, so long as you understand that with a higher expected return, you should expect more volatility as well,” Adams says.

Not Contributing Enough

Some 401(k) investors have lower-than-expected returns in their 401(k) because they are not contributing enough to receive an employer’s free matching contribution.

“A company matching contribution is like an immediate 100% return on investment,” says Kyle Harper, a certified financial planner with Harper Financial Planning.

So don’t miss out on this free money from your employer. If your company offers a 3% matching contribution, invest 3% into your 401(k), and receive the additional 3% contribution from your employer for your retirement savings.

The Bottom Line

Discovering that your 401(k) is underperforming is not good news. But there are things you can do to gain a greater return on your investment.

If you have been investing in a target date fund, you may want to move to a more aggressive investment, such as a large-cap growth fund. If you are paying high fees in your 401(k), switch to investments with low fees aligned with your financial goals. If you bounce around from investment to investment, seeking higher returns, choose an investment that will meet your financial needs and stick around for the long term.

If you’ve been conservative with your investments, you may want to move to a more aggressive stock fund. Finally, don’t forget to contribute enough money into 401(k) to qualify for a company’s matching contribution. That’s free money from your employer that you can use for your 401(k) investments.

A 2024 survey from Empower reports that nearly 37% of Americans aren’t prepared to handle a $400 emergency expense. In fact, it claims that over 1 in 5 Americans have no emergency savings. This isn’t particularly shocking, as in 2023, the Federal Reserve Board, in a report on the economic well-being of U.S. households, considered adults who had 3 months’ emergency savings, and this amounted to just 54%.

When financial experts recommend keeping three to six months of essential expenses safely tucked away, running out of that safety net sometimes will feel like a huge financial failure. But the reality, stark as it is, is that emergency funds are meant to be used during emergencies. So the real test isn’t whether you’ve depleted your fund but how strategically you respond when those resources are gone.

Your emergency fund can evaporate due to medical bills, job loss, income reduction, or a series of unfortunate events, and if you want to deal with this, you’ll need to plan thoughtfully. The following five steps will help you navigate such a challenging financial period.

Key Takeaways

• According to the Consumer Financial Protection Bureau’s Making Ends Meet survey in 2022, nearly a quarter of consumers (24%) have no savings set aside for emergencies, while 39% have less than a month of income saved for emergencies.
• Treat your emergency fund as a last-resort safety net by using it only for true emergencies not for non-urgent expenses like vacations or lifestyle upgrades.
• When rebuilding your depleted emergency fund, make saving an automatic part of your budget.
• Consider a temporary lifestyle adjustment by cutting non-essential expenses, finding additional income sources through side hustles, and selling unused items to accelerate your emergency fund replenishment.

Implement an Emergency Budget Overhaul

“Rebuilding requires intentional budgeting” said Netta Stahl. The Tel Aviv based financial coach says “sticking with old spending patterns while trying to replenish the fund will only slow progress.” The big question now is “how do you implement an emergency budget overhaul?”

Create an entirely new emergency budget that reflects your current financial reality. It’s best to not see this just as an attempt to trim expenses but to see it as restructuring your spending priorities.

• Review every recurring expense and eliminate anything non-essential.
• Reallocate funds toward immediate needs.
• Consider implementing creative cost-cutting measures like “themed” budget days (such as “ramen Tuesdays” or “no-spend weekends”).

 Proactively Contact Your Creditors

Don’t wait until you miss payments to reach out to lenders and service providers. Contact them immediately when you anticipate potential payment difficulties. Many creditors offer hardship programs that can temporarily lower interest rates, waive fees, and adjust payment terms. These programs typically last a few months and allow more of your payment to go toward principal. This way, you can make meaningful progress on your debt while managing cash flow during your emergency fund rebuild phase. Stahl advises, “Never take the first offer just because you’re stressed. Desperation can lead to expensive mistakes, so explore a few options before locking yourself into high-interest debt.”

Strategically Pause Other Financial Goals

Temporarily redirecting funds from other financial objectives can help you rebuild your emergency fund faster:

• Calculate the minimum contributions needed to maintain employer matches on retirement accounts.
• Evaluate the long-term cost of pausing investments versus the immediate need for cash reserves.
• Consider reallocating funds from long-term savings goals (e.g., vacation or home down payment) to your emergency fund.
• Explore options to temporarily reduce or suspend payments on student loans or other non-essential debts.
• Set clear milestones for when you’ll resume normal contributions to avoid indefinitely neglecting important financial goals.
• Use this pause as an opportunity to reassess and potentially reprioritize your long-term financial objectives.

You have to consciously be aware that this isn’t about abandoning long-term goals but prioritizing immediate financial security. “Remind yourself that this is temporary. It’s a season, not a permanent lifestyle,” Stahl notes.

Secure a Part-Time Freelance Gig

You can increase your income using freelance work if your emergency funds run out. Leverage platforms like Upwork, LinkedIn, Fiverr, or industry-specific job boards to find opportunities in your field. Some skills are popular in the freelance gig space: content writing ,virtual assistance, graphics designing, etc. You can try learning these skills or leveraging them for freelance work. You can also offer specialized consulting in your professional field. Consider creating and selling digital products (e.g., online courses, eBooks) that can generate passive income over time. Network within professional associations or alumni groups to find higher-paying, specialized freelance work. Invest in enhancing your skills through free online courses to increase your earning potential. Track all freelance income and expenses meticulously for tax purposes and to gauge the effectiveness of your efforts.  The flexibility of freelance work allows you to scale hours based on your needs.

Transform Unused Assets Into Emergency Capital

This is perhaps the most innovative of the steps, going well beyond the typical “sell your stuff” advice. Look beyond the traditional selling of household items by conducting a comprehensive “asset audit” of your life. This includes evaluating physical possessions, digital assets, unused subscriptions, reward points, cashback opportunities, and even specialized knowledge you could monetize. For physical items, consider not just selling but also renting valuable possessions through platforms like Fat Llama or Turo. Digital assets like unused domain names, photos, or creative works might find buyers on specialized marketplaces. Check out peer-to-peer rental platforms for high-value items like cameras, musical instruments, or sports equipment. You can even consider selling or licensing intellectual property, such as patents or copyrights you may hold.

Stahl cautions against trying to “invest” your way back: “Some people feel pressure to replace the fund fast and take unnecessary risks like putting their emergency savings into stocks or crypto.” That defeats the purpose of an emergency fund. This money isn’t meant to grow, it’s meant to be there when you need it.

Bottom Line

Remember, rebuilding your emergency fund is a process. Stahl estimates that it takes “just over one year to fully replenish a 6-month emergency fund” for most people. Stay focused, adjust your lifestyle temporarily, and prioritize your financial security. Also, remember that a depleted emergency fund is not a failure. In fact, it’s proof that your system worked. Now, it’s time to get back on track.

If you have a business, you may need to fill out IRS Form W-9

Fact checked by Suzanne Kvilhaug

Form W-9 from the Internal Revenue Service (IRS), Taxpayer Identification Number and Certification, is used by businesses to collect tax information from third parties such as contractors. The information collected on Form W-9 is then used by the business to fill out either Form 1098 or Form 1099 at tax time.

Key Takeaways

• IRS Form W-9 is most often used by businesses to collect tax information about contractors the business works with.
• The information on Form W-9 is used to fill out Forms 1098 and 1099 at tax time.
• Form W-9 collects information including name, address, tax classification, Social Security number or EIN, and withholding information.
• The person or company submitting Form W-9 must sign and date it. Willfully reporting incorrect information can result in fines or penalties.
• Because Form W-9 contains sensitive identification information, both parties should exercise caution when sending or storing it.

Purpose of Form W-9

IRS Form W-9 is used to gather taxpayer information from a vendor, contractor, or other non-employee that a business is working with. Compensation paid to non-employees must be reported to the IRS if it meets four requirements:

• A payment (or payments) was made to someone who is not an employee.
• Payment was made for services during business operations.
• The payment was made to an individual, partnership, estate, or (in some cases) corporation.
• The total payments made over a year were at least $600.

If these requirements are all met, the business must report the payments to the IRS on Form 1099-NEC Non-Employee Compensation. Form W-9 is used to gather the necessary taxpayer information to correctly fill out Form 1099-NEC, which the third party then uses to self-report their income to the IRS at tax time.

Note

Non-employee compensation was previously reported in Box 7 on Form 1099-MISC.

In addition to providing the information necessary for a business to report payments to a third party, it also protects the business. The party filling out Form W-9 must sign to certify that the information is true and correct. A signature on Form W-9 certifies:

• The tax identification number (TIN) provided, such as a Social Security number or Employer Identification Number (EIN)
• Any exemption from backup withholding
• The FATCA code used by the vendor

Form W-9 is not sent to the IRS. Instead, both the business and the third party should keep copies of it for their records.

Note

Both parties should use caution when sending or storing Form W-9, as it contains sensitive taxpayer information.

Form W-9 can be used for tax reporting in other situations as well. It can be used by banks or other financial institutions to fill out Form 1099-INT (interest income), 1099-B (broker and barter transactions), or 1099-DIV (income from dividends and distributions). Taxpayers may also have to fill out Form W-9 in other situations when they receive income, such as:

• Real estate transactions, reported on Form 1099-S
• Canceled debt, reported on Form 1099-C
• Tuition reimbursements or payments, reported on Form 1098-T

If you are an independent contractor and refuse to fill out Form W-9, your client will withhold taxes from payments at a rate of 24% in order to avoid fines from the IRS.

Who Should Fill Out Form W-9?

Form W-9 is only used for taxpayers who are U.S. persons. This includes individuals who are both citizens and resident aliens, as well as U.S. partnerships, estates, corporations, or domestic trusts.

In general, those who need to fill out Form W-9 are non-employees.

If you are an employee, you will not need to fill out Form W-9 for your employer. Instead, you will fill out Form W-4 to provide your taxpayer information, which your employer will then use to withhold income taxes from your paycheck, as well as Social Security and Medicare taxes. You will then receive Form W-2 when it is time to file your tax return.

Warning

If you are classified as an employee, your employer should not ask you to fill out Form W-9. If an employer does so, it may be a sign that they are illegally trying to save money by classifying you as an independent contractor rather than an employee.

Independent Contractors

If you are an independent contractor, freelancer, or other non-employee, you do not have an employer withholding taxes from your paycheck. Instead, you will need to pay estimated taxes throughout the year to cover your income, Social Security, and Medicare taxes.

The businesses that you work with will collect Form W-9 from you when you begin working together, and this information will then be used to report your income from that business on Form 1099.

Once you receive any version of Form 1099 or 1098, you must report that income in your tax return and pay any remaining taxes due on it.

Financial Transactions

Even if you are not an independent contractor or freelancer, you may be asked to fill out Form W-9 for certain financial transactions. Financial institutions, such as banks or brokerages, may collect.

Form W-9 so they have customer taxpayer information on file when they need it to fill out forms such as Form 1099-INT or 1099-B. If you are involved in real estate transactions, the business you are working with may ask you to complete a W-9 as well.

Important

Before filling out and submitting Form W-9, always ensure that the person or institution requesting the form has a legitimate need for it. Beware of W-9 phishing scams sent via email or text. If you are not sure whether or not you should submit a form W-9, consult a tax professional.

Information on Form W-9

There are three sections of Form W-9, and it is used to collect eight pieces of taxpayer information:

• Line 1, Name of entity/individual: Enter the name shown on your tax return; this can be either an individual name or the name of an owner, sole proprietor, partnership, or other entity.
• Line 2, Business name: The line is only filled out if you have a trade name, business name, DBA, or other disregarded entity name.
• Line 3, Federal tax classification: Choose only one of individual/sole proprietor, C corporation, S corporation, partnership, trust/estate, or LLC (limited liability company); if you select LLC, fill out Line 3b to indicate whether it is a C corp, an S corp, or a partnership.
• Line 4, Exemptions: Indicate whether you are exempt from backup withholding or FATCA reporting.
• Line 5 and Line 6, Address: Enter your address, city, state, and ZIP code.
• Line 7, Account numbers: If requested, you may enter additional information such as client information for a bank or brokerage.
• Part I, Tax identification number (TIN): Your TIN may be a Social Security number (SSN) or an EIN.

Note

If you are a sole proprietor, you can enter either your SSN or EIN. If your business is a corporation or partnership, enter the business’s EIN. If your business is a single-member LLC that is a disregarded entity, you can use either your SSN or EIN but not the business’s EIN.

The final part of Form W-9 is Part II (Certification), where you must sign and date the form before submitting it.

Penalties for Incorrect Information on Form W-9

When you sign Form W-9, you are certifying that you have provided correct information to the best of your knowledge. If you provide false information or otherwise fail to comply with reporting requirements, you may be subject to penalties including:

• A fine of $50 for every failure to provide your correct TIN
• A fine of $500 for making a false statement that results in no backup withholding
• Criminal penalties, including fines and/or imprisonment, for willfully falsifying any information

However, these penalties can be waived if you are able to prove that you were not deliberately providing false information.

Penalties aren’t limited to the person filling out the W-9. Anyone requesting a W-9 may be subject to either criminal or civil penalties if they disclose or use tax identification numbers in a way that violates federal law.

The Bottom Line

Form W-9 is primarily used by independent contractors, freelancers, and other vendors to provide their taxpayer information to clients. This information is then used to fill out Forms 1099 and 1098, which are used for filing taxes and reporting income to the IRS.

Before submitting a W-9, the submitter must sign and certify that the information on it is correct. Deliberately providing false information on a W-9 can result in criminal and civil penalties. Anyone submitting or requesting a W-9 should store this information carefully to prevent it from being incorrectly used.

Fact checked by Betsy Petrick

Refinancing a mortgage is typically done when someone wants to take advantage of lower interest rates or to change the repayment term of their mortgage. Usually, a person will refinance a mortgage to save on their monthly payments. Since mortgages are personalized products, there are no hard and fast rules about the best time to refinance. This is why it’s important to consider factors like your credit score, the current interest rate, and how much equity you have before you refinance your loan.

Key Takeaways

• Refinancing your mortgage can result in lower monthly payments, but you’ll have to pay hefty fees to refinance the loan.
• Most lenders require you to have at least 20% equity in your home to refinance your mortgage.
• Whether or not it makes sense to refinance depends on your financial situation and the terms of the new loan you’re offered.

Pros and Cons of Refinancing Your Mortgage

It’s easy to highlight the benefits of refinancing since it has the potential to save you a lot of money. However, there are some drawbacks that may come with changing the terms of your loan.

Pros

• You could pay less in interest on the loan

• Your monthly premium can be lower

• You can get a shorter term

• You can avoid private mortgage insurance (PMI)

• You can change mortgage products

• You can cash out some of your equity

Cons

• You’ll have to pay closing costs again

• It takes time to research lenders and loans

• Your credit score will likely take a hit

• You might take on more debt or have a higher monthly payment

Pros Explained

• You could pay less in interest on the loan: If you refinance at a lower interest rate, the total amount of interest you’ll pay over the life of the mortgage could be significantly lower.
• Your monthly premium can be lower: If interest rates have dropped since you took out your original mortgage, you can refinance and save money on your monthly payment. By putting that savings toward the loan’s principal, you might be able to pay off your mortgage faster.
• You can get a shorter term: Since you’re getting a new mortgage, you might choose a loan with a shorter term, as this will allow you to save on interest in the long run.
• You can avoid private mortgage insurance (PMI): If you hold at least 20% equity in your home when you refinance, you can avoid paying for PMI.
• You can change mortgage products: You might decide you’d prefer a different type of loan, such as an adjustable-rate mortgage (ARM). Refinancing gives you options.
• You can cash out some of your equity: Depending on how much equity you have, you can get a cash-out refinance and take out a larger loan. By paying off your current mortgage with the funds, you’ll still have money left over for other things like paying down debt, education expenses, or medical bills.

Cons Explained

• You’ll have to pay closing costs again: You can expect to pay 3% to 6% of the loan’s balance in closing costs. These cover things like appraisals, origination fees, recording costs, underwriting, and title services.
• It takes time to research lenders and loans: You’ll need to thoroughly investigate refinance lenders and loan options in order to find the most advantageous one for you, which could take more time than you want to spend.
• Your credit score will likely take a hit: To issue the new mortgage, your lender will make a hard inquiry, which can cause your score to drop. Although the effect on your score would only last a few months, the hard inquiry will stay on your report for two years.
• You might take on more debt or have a higher monthly payment: If you opt for a loan with a longer term length or take out a larger amount, you could end up paying considerably more each month than you are now.

Factors to Consider Before You Refinance Your Mortgage

Property Value and Your Equity

To find out if you’re even eligible to refinance, you need to find out what your home is currently valued at and how much equity you have in the property. Equity is basically the percentage of your home that you own.

To determine your equity, take your home’s current property value and subtract your current loan balance. Then, to determine your equity as a percentage, divide how much equity you have by the home’s value, and then multiply by 100.

Generally, lenders ask that you have at least 20% home equity before refinancing. Be aware that if your home’s property value has dropped, you may have negative equity. In this case, refinancing wouldn’t benefit you.

Example

If your home is valued at $300,000 and you currently owe $225,000, you would subtract what you owe to find the equity. Since $300,000 – $225,000 = $75,000, you would have $75,000 in equity.

To express this as a percentage, divide the equity by the home’s value. Since 75,000/300,000 = 0.25, you multiply the result by 100 to get 25%.

Your Credit Score

Pull up your credit score to see if it’s the same or improved since you took out your mortgage. Lenders look at your credit score to determine whether they’ll issue you credit and, if so, what interest rate to offer you.

The higher your credit score, the more favorable your interest rates will be. If your credit score has deteriorated since you took out your mortgage, the refinance lender might not offer you better terms. Instead, you may want to improve your credit score before refinancing down the road.

Your Debt-to-Income Ratio

In addition to looking at your credit score, lenders check your debt-to-income (DTI) ratio. This is how much debt you have in comparison to your income. Most lenders want to see low DTI ratios—ideally 36% or less—although some lenders might be willing to go up to 43%.

Calculating DTI Ratio

To figure out your DTI ratio, divide your total monthly debt payments by your gross monthly income. For example, if your mortgage payment is $1,500 and you also have another $1,000 worth of monthly payments that go toward your car and other debt, that adds up to a monthly debt payment of $2,500. If your gross monthly income is $7,500, you would divide $2,500 by $7,500, which comes out to a DTI of 33%.

The Costs of Refinancing

Refinancing isn’t free. There are closing costs, which could cost you between 3% and 6% of the total loan amount. These usually include origination fees, appraisal fees, title services, underwriting, and more.

Some lenders might offer to roll these fees into the loan, but that just means your loan will be that much larger. Others offer a “no-cost” refinance, which usually comes with higher interest rates to offset the cost to the creditor.

If you roll fees into the loan, be careful that doing so doesn’t push your loan-to-value (LTV) ratio to greater than 80% or else you’ll need to pay private mortgage insurance (PMI), which would add yet another cost.

Introductory Rates

If you have an ARM, pay close attention to what interest rate you’re currently paying compared to what you’ll pay after refinancing. You might be able to refinance to another ARM or a fixed-rate loan at a lower interest rate, but that’s not guaranteed.

You should also decide if you’ll pay refinancing points to reduce your loan’s interest rate. The cost of each point is equal to 1% of the loan amount. If you do choose to use refinancing points, be sure to factor this into the overall cost of refinancing.

Consider how long you have left on your current mortgage term. When you refinance, your term essentially restarts. So, if you’re close to paying off your mortgage, you might want to refinance with a shorter term so you can quickly pay off the new loan.

Your Current Lender

While it’s always a good idea to shop around for lenders, it might pay off to try and reach a new agreement with your current lender. After all, they probably don’t want to lose your monthly payment, so they may be willing to renegotiate your mortgage’s interest rate and/or term length.

This can be a particularly effective move if your credit score or DTI ratio has improved, as you can prove that you qualify for better interest rates with other lenders.

Your Breakeven Point

A major reason to refinance your mortgage is to save money on your payments. If refinancing won’t save you money, there’s likely no reason for you to go through the hassle. To help you figure out whether you’re actually saving, you need to determine your breakeven point. This is when the costs of refinancing your mortgage equals the savings you’d get from doing so.

To find your breakeven point, calculate all of your refinancing costs. Next, determine how much money you’d save each month with your refinanced loan. Then, divide the total cost of refinancing by the amount of money you’d save every month. The result is the number of months it will take you to breakeven after refinancing.

Your Taxes

As a homeowner, you might have enjoyed a heavy tax deduction by claiming your mortgage interest. If you always rely on this deduction to reduce your taxable income, be prepared to claim less if you refinance and your mortgage payment is significantly lower.

If you take the standard deduction, this factor doesn’t affect you since you can automatically take a $15,000 deduction for single filers or $30,000 for married couples filing jointly in 2025 (up from $14,600 or $29,200 for 2024).

Loan Consolidation as an Alternative

If your mortgage is just one type of debt you have and you’re trying to get a handle on your personal finances, consider another option: loan consolidation. Instead of refinancing your home, which uses your home as collateral, you might focus on consolidating your other debts into a single loan so they’re more manageable.

For instance, you can combine your student loans, credit card debt, medical debt, and personal loans, so you’re paying only one bill. However, be aware that debt consolidation loans usually have higher interest rates.

Warning

Mortgage lending discrimination is illegal. If you think you’ve been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps that you can take. One such step is to file a report with the Consumer Financial Protection Bureau (CFPB) or the United States Department of Housing and Urban Development (HUD).

Why Refinance Your Mortgage?

People refinance their mortgages for a variety of reasons, including to get a lower interest rate and monthly payments, to shorten the term of the mortgage, to convert from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage (or fixe-rate to ARM), or to access home equity.

What Is a Cash-Out Refinance?

A cash-out refinance is a mortgage refinancing option that lets the borrower convert home equity into cash. In this scenario, a borrower takes out a new mortgage for more than the previous mortgage balance, and the difference between the two is paid out in cash.

Should You Refinance Your Mortgage When Interest Rates Decline?

In some cases, lower interest rates may result in mortgage rates that are lower than what you are paying currently, making refinancing a viable option. However, lower interest rates could still leave mortgage rates at a higher level than the mortgage rate you already have. If you can negotiate a lower interest rate and intend to stay in your home long enough to cover the refinance closing costs, then refinancing could be the smart choice.

The Bottom Line

When interest rates drop, it might seem like everyone rushes to refinance. However, it’s crucial to do your own research to determine if refinancing makes the most sense for you. For instance, once you compare all the costs to how much you actually stand to save, you’ll have a better idea. If you’re still unsure whether refinancing is the right move for you, consult with a financial advisor.

Reviewed by Amy Drury
Fact checked by Yarilet Perez

Production Costs vs. Manufacturing Costs: An Overview

Production costs reflect all of the expenses associated with a company conducting its business while manufacturing costs represent only the expenses necessary to make the product.

Both of these figures are used to evaluate the total expenses of operating a manufacturing business. The revenue that a company generates must exceed the total expense before it achieves profitability.

Key Takeaways

• A factory’s production costs are the total expenses of doing business.
• Manufacturing costs are the expenses directly related to building the product.
• Both production costs and manufacturing costs must be included in the calculation of the per-item cost of doing business.

Production Costs

Costs of production include many of the fixed and variable costs of operating a business. Raw materials and labor are production costs.

Fixed costs typically include:

• Building rent
• Advertising budget
• Business equipment
• Other miscellaneous expenses that do not go up or down with moderate changes in the volume of business

Variable costs increase or decrease as production volume changes. Some variable costs are:

• Supplies
• Wages
• Any other expenses that change with the level of production

Manufacturing businesses calculate their overall expenses in terms of the cost of production per item. That number is, of course, critical to setting the wholesale price of the item.

As the rate of production increases, the company’s revenue increases while its fixed costs remain steady. Therefore, the per-item cost of manufacturing falls and the business becomes more profitable.

A lower per-item fixed cost motivates many businesses to continue expanding production up to its total capacity. This allows the business to achieve a higher profit margin after considering all variable costs.

Manufacturing Costs

Manufacturing costs, for the most part, are sensitive to changes in production volume. Total manufacturing expenses increase as production increases.

Important

The opportunity to achieve a lower per-item fixed cost motivates many businesses to continue expanding production up to total capacity.

The per-item cost does not change substantially. Nonetheless, additional production always generates additional manufacturing costs.

Manufacturing costs fall into three broad categories of expenses: materials, labor, and overhead. All are direct costs. That is, the salary of the company accountant or the accountant’s office supplies are not included, but the salary and supplies of the foreman are.

Production Costs vs. Manufacturing Costs Example

For example, a small business that manufactures widgets may have fixed monthly costs of $800 for its building and $100 for equipment maintenance. These expenses stay the same regardless of the level of production, so per-item costs are reduced if the business makes more widgets.

In this example, the total production costs are $900 per month in fixed expenses plus $10 in variable expenses for each widget produced. To produce each widget, the business must purchase supplies at $10 each. Each widget sells for $100. After subtracting the manufacturing cost of $10, each widget makes $90 for the business.

To break even, the business must produce 10 widgets every month. It must make more than 10 widgets to become profitable.

What is the Marginal Cost of Production?

The marginal cost of production refers to the cost to produce one additional unit. Theoretically, companies should produce additional units until the marginal cost of production equals marginal revenue, at which point revenue is maximized.

How to Calculate Total Manufacturing Cost?

There are three main components that make up total manufacturing costs. These include direct materials (raw manufacturing materials), direct labor (the wages for the workers who directly produce manufactured goods), and manufacturing overhead (indirect costs necessary for production like utilities, equipment maintenance, and rent).

Are Wages a Fixed Cost or Variable Cost?

Wages can be either a fixed or variable cost depending on how they’re structured. Salaries are typically a fixed cost, as they must be paid regardless of how much product a company produces. In contrast, hourly wages, overtime pay, and commissions are usually classified as a variable cost, as they can fluctuate with production levels.

The Bottom Line

Production costs encompass all the costs required for a company to operate while manufacturing costs only represent the costs needed to produce products. In theory, companies should produce enough goods to cover their production costs to maximize revenue but stop once marginal costs equal marginal revenue. Manufacturing costs can change over time and depending on production levels, so it’s important for businesses to closely track variable inputs such as material and labor to ensure production doesn’t eat away at revenue.

Fact checked by Suzanne Kvilhaug
Reviewed by Andy Smith

The Caste System: An Overview

Discrimination against individuals based on caste would seem to be a relic of the past. Even in India, where the caste system was most rigid, the practice has been officially banned since 1950.

Essentially, a caste system is a rigid assignment of social status based on inheritance. Recent history shows that caste discrimination has by no means disappeared, even in the United States.

In the Hindu caste system, people are placed at birth into “varna” and “jati,” social groups within a strict hierarchy. Historically, caste assignment restricted the individual to certain occupations. Castes did not intermingle.

In various forms, such discrimination has existed in many nations. Generations of immigration have brought issues of caste to the U.S.

Key Takeaways

• Caste system discrimination is the exclusion of individuals from opportunities based on the social level of their families.
• Caste discrimination continues to be linked to poverty, lack of access to public resources, and a lack of job opportunities.
• Even in countries that have outlawed discrimination, issues of caste discrimination are being raised.

Historical Context of Caste System

The modern caste system developed in India. The fragmentation of the Mughal Empire led, in the centuries before the British Raj, to the spread of caste archetypes as a way to cement political legitimacy and social status.

These drew on traditional Hindu social stratifications that many scholars believe traded on notions of ritual purity and contamination. During British rule, caste became a convenient and useful shorthand for the complexities of the region.

By the time of the India independence movement, attempts to topple caste dynamics had gained ground. In 1950, India’s constitution banned caste discrimination and launched a quota system meant to rectify historical injustices against the lowest castes.

However, many argue that caste discrimination still persists in far-reaching ways to this day.

Modern Caste System Discrimination

Caste encourages exclusion, which creates or worsens inequality for those who find themselves at the bottom of its hierarchy. Within the Indian caste system, occupations were historically inherited. That, combined with social stratification—especially through endogamy, which allows people to marry only within their castes—created a rigid system.

Although perceptions of outright discrimination within India are low, there’s evidence that these rigid social distinctions continue to play a role in contemporary life.

There are stark examples of discrimination, too.

Those in disfavored jatis, particularly in rural areas, have reportedly been forced to sell their children into debt bondage—in places where legislation against the practice isn’t fully imposed—or are themselves forced into low-paying work like cleaning waste.

Segregation by caste is linked to lack of education, poor health, and even deficient access to humanitarian relief after disasters.

Impact of Caste Discrimination

For someone living within it, a caste system restricts education, occupation, and the ability to practice one’s religion. Practically, at the community level, caste fuels inequality, as the system allows for the control of resources by higher castes.

There is a strong gender element to the ramifications of caste as well. Women who belong to a “scheduled caste”—one that falls low in the hierarchy—suffer higher incidents of domestic violence, according to a study in the National Library of Medicine.

Illegalizing the Caste System

B.R. Ambedkar, an early critic of caste inequality, wanted to reshape Indian society on democratic and egalitarian principles. For him, this meant an annihilation of caste, an oppressive hierarchy that led necessarily to inequality by controlling resources and opportunities within a closed system.

Ultimately, for Ambedkar, ending caste meant breaking away from the traditional beliefs that justified it, something that would happen through a mix of reforms, laws, education, and marriages between castes.

Ambedkar was instrumental in making caste discrimination illegal in India. He also influenced “reservation,” a form of affirmative action for public jobs written into India’s constitution that seeks to redress caste discrimination. 

The reservation system was revised in 2019 to focus more on economic status than caste designations.

Modern Remnants of Caste System

Some researchers and academics have found evidence that caste continues to influence life outcomes, which might even have been worsened by the COVID-19 pandemic.

Ashwini Deshpande, a professor of economics at Ashoka University in India, has argued that data from India concerning job losses during the pandemic suggested that differences in job losses between castes could not explained by education, industry, or occupation. This data suggests, Deshpande and her co-author wrote, that “caste is not merely a proxy for class, and identity-based policies might be essential to overcoming these disparities.”

The Anti-Caste Movement

Within the caste system, a group known as Dalits occupied the lowest rung of the hierarchy. They were deemed “untouchables.”

Post-independence, electoral politics have given Dalits a means to relieve some of the ill effects of caste. But many feel that these have insufficiently weakened the impact of caste.

Perhaps unsurprisingly, resistance has taken a variety of forms.

One example: Caste discrimination may have increased religious conversion from Hinduism, with which the caste system is popularly affiliated, into Christianity and Islam.

Violence against Dalits has occasionally inspired more radical political groups, such as the Dalit Panthers, a social and political organization popular in the second half of the 20th century that modeled itself on the Black Panther Party in the U.S.

International Perspectives

International observers tend to emphasize the role of caste discrimination in furthering inequality.

Human Rights Watch, a nonprofit human rights advocacy group, has called caste “a hidden apartheid of segregation, modern-day slavery, and other extreme forms of discrimination, exploitation, and violence.”

Elsewhere, advocates have termed belonging to an “untouchable” jati a “social disability.”

Those such as Rita Izsák-Ndiaye, a former United Nations Special Rapporteur on minority issues, believe that castes violate international principles of universal human dignity and equality because they subjugate some groups of people below others while fortifying poor socioeconomic circumstances for “lesser” castes.

Caste Issues in the U.S.

Issues related to caste have arisen in the U.S. in recent years, particularly in communities and regions that have substantial populations of immigrants from nations where caste systems are, or were, in place.

The city of Seattle, Washington, passed the first such law outside of Asia in 2023, in response to pressure from some of the state’s 150,000 Indian American residents, who argued that caste discrimination should be included among the discriminatory practices prohibited by law.

A similar state-wide measure in California was passed by the state’s legislature but vetoed by Gov. Gavin Newsom in 2023 on the grounds that the state’s current laws against discrimination protected against caste bias, even if not explicitly.

Prejudice produced by caste distinctions has become a management concern as well, with notable corporations beginning to address the issue. Alphabet, Amazon, Apple, and Del are among the companies that have policies addressing caste discrimination.

Is Caste Discrimination a Problem Outside of Asia?

The word caste is most often associated with modern India but effective caste systems have existed throughout the world.

In modern times, diaspora communities have noted that caste discrimination continues to harm their lives. Some large U.S. corporations have put anti-caste discrimination policies in place. Seattle was the first U.S. city to explicitly outlaw caste discrimination, in 2023.

What Role Does Caste Play in People’s Lives?

A caste system determines an individual’s access to education, jobs, and opportunities of all kinds based strictly on birth.

Does India Have Affirmative Action?

India has a quota-based affirmative action program, usually called “reservations,” that is written into its constitution. The program was intended to alleviate the inequality suffered by disfavored “jatis.”

In 2019, the program was altered to reserve resources more broadly for “economically weaker groups.” In 2023, India’s Parliament passed a law to create a reservation system ensuring that women would hold 33% of the seats in state legislatures and the lower House of Parliament.

The Bottom Line

Caste system discrimination turns a rigid social hierarchy into a system of exclusion. Those at the bottom of the hierarchy face severe deprivation and limited opportunity.

Remnants of the caste system continue today in nations around the world. Some are being addressed with a goal of eradicating discrimination based on birth.

Reviewed by David Kindness
Fact checked by Vikki Velasquez

The Social Security program was established in 1935 to provide retirement income for certain U.S. workers. It was later expanded to cover most of the country’s workforce and remains America’s pension plan and the financial lifeline many people use to stay afloat during retirement.

In 2025, nearly 69 million Americans per month will receive a monthly Social Security benefit, totaling roughly $1.6 trillion in paid benefits. Social Security benefits represent about 31% of the income of people over age 65.

Key Takeaways

• Social Security income is an important public pension system in the United States.
• Americans become eligible for Social Security benefits at age 62, but benefit amounts depend on how early individuals elect to start.
• Full retirement benefits are paid at age 67 for people born in 1960 or after, and age 66 for those born from 1943 to 1954.

1. When Am I Eligible?

Individuals are eligible for full retirement benefits as early as 65 or as late as 67. If you opt to receive Social Security at age 62, monthly benefits are permanently reduced. For example, for those who take benefits at 62 with a full retirement age of 66, benefits are reduced by 25%.

Those who postpone benefits past full retirement age are rewarded with a higher benefit: 8% for each year up to age 70 for those born in 1943 or later, when benefits max out and there is no further incentive to delay signing up.

• If you were born before 1938, your full retirement age is 65.
• If you were born from 1938 to 1942, the age ranges from 65 and two months to 65 and 10 months.
• If you were born from 1943 to 1954, it’s 66.
• If you were born from 1955 to 1959, it ranges from 66 and two months to 66 and 10 months.
• If you were born in 1960 or later, it’s 67.

2. How Is Eligibility Determined?

Eligibility for Social Security is based on credits earned during an individual’s working years. As of 2025, for every $1,810 you make, one credit is earned, up to a maximum of four per year. If you were born in 1929 or later, you need 40 credits or 10 years of full-time work to receive Social Security benefits.

3. How Much Do I Pay in?

As of 2025, workers pay 6.2% of their wages into Social Security, up to $176,100 of their income. Employers contribute another 6.2%. Self-employed individuals have to pay both portions, or 12.4%.

Tip

You can collect Social Security retirement benefits even if you’re still working.

4. How Much Will I Get?

Social Security benefits are based on lifetime earnings. The formula is complicated, but it averages the income from your 35 highest-earning years. If you already accumulated 40 Social Security credits, you can use the online Social Security Retirement Estimator to calculate your benefit.

5. Can I Get Social Security If I Work?

Individuals can receive Social Security benefits while they work. If you’ve reached full retirement age, you can earn as much as you’d like and receive full benefits. If you’re under full retirement age, your benefits are temporarily reduced. Social Security will credit the reduction to your record when you reach full retirement age, resulting in a higher benefit.

The reduction is $1 for every $2 of earned income over $23,400 in 2025 for those younger than full retirement age. The year you reach full retirement age, benefits will be reduced by $1 for every $3 in income over $62,160 in 2025 and continue until the month when you become fully eligible.

Important

Retirees can contribute to individual retirement accounts (IRAs) as long as they have earned income. However, Social Security benefits are not considered earned income for this purpose.

6. How Does the Spousal Benefit Work?

Spouses can claim benefits regardless of whether they ever held paid jobs based on their partner’s record. To qualify, the spouse with a work history must be receiving retirement or disability benefits, and the nonworking spouse must be at least age 62.

Spousal benefits are permanently reduced if the nonworking spouse collects before full retirement. If the nonworking spouse waits until full retirement age, they will receive a spousal benefit of up to 50% of their partner’s full retirement benefit.

Widowed spouses become eligible for 100% of their partner’s full benefit unless the benefit they’ve earned through their income is higher. Generally, the widowed spouse must be at least 60 years old to receive benefits from the deceased spouse’s record, and the amount will be reduced if the surviving spouse elects to receive benefits before their full retirement age.

Important

If a surviving spouse remarries before age 60, they will forfeit the deceased spouse’s benefit. In some cases, divorced spouses are also eligible for spousal benefits based on their former partner’s record.

7. Do I Owe Taxes on Social Security?

Individuals pay federal income taxes on their benefits if their combined income, which includes 50% of their benefit amount plus any other earned income, exceeds $25,000 per year for single filers. For those who file jointly, the income limit is $32,000.

8. How Do I Apply for Benefits?

You can apply at a local Social Security office, by phone (1-800-772-1213), or online. Applications require documents such as a birth certificate. Social Security Form SSA-1 has a complete list. The Social Security Administration (SSA) allows individuals to apply up to four months before the date they want their benefits to start.

9. How Is Social Security Funded?

Money paid in by current workers through taxes is used to pay the benefits for current retirees. Any remaining money goes into the Social Security Trust Fund, used in future years when current contributions become insufficient to cover all of the program’s obligations.

Two trust funds pay retirement benefits: the Old-Age and Survivors Insurance (OASI) Trust Fund and the Disability Insurance (DI) Trust Fund. By law, the money in the trust funds is invested in U.S. government securities.

10. Is Social Security in Trouble?

The Social Security system faces financial challenges as fewer workers pay into the system for every retiree who is drawing money out. People are living longer than when the program was envisioned in the 1930s and collecting benefits for more years.

The two funds that maintain Social Security are the Old-Age and Survivors Insurance (OASI) Trust Fund, which pays Social Security retirement benefits, and the Disability Insurance (DI) Trust Fund, which pays Social Security related to disability. According to the 2024 Trustees Report, the retirement program is projected to pay full benefits until 2035, when the trust fund will be depleted. After this, 83% of scheduled benefits will be paid with continuing tax income.

As of 2024, the OASI Trust Fund is expected to be depleted by 2033, when it will only pay out 79% of benefits. The Disability Insurance (DI) Trust Fund is projected to pay 100% of total scheduled benefits through 2098.

What Is the Maximum Social Security Benefit You Can Get?

In 2025, the maximum Social Security benefit for someone retiring at full retirement age is $4,018. The full retirement age is 66 to 67, based on the date of birth.

Should You Take Social Security at 62 or 67?

You can start receiving retirement benefits at 62 years old, but the amount will be higher if you wait until the full retirement age, which is either 66 or 67, depending on when you were born. Those who wait even longer, until age 70, can see an increase in benefits each year until retiring.

How Much Is the Social Security Cost-of-Living Adjustment?

The Social Security cost-of-living adjustment (COLA) for 2025 is 2.5%. The COLA is determined using a formula outlined in the Social Security Act to help beneficiaries keep up with inflation. The formula uses increases in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) from the third quarter of the previous year when a COLA was approved to the third quarter of the next year.

The Bottom Line

Social Security is a popular and important pension in the lives of Americans during their retirement years. Knowing how to manage the ins and outs and understanding the benefits of Social Security allows individuals to maximize their benefits.

People who file after full retirement age may be eligible for a lump sum

Reviewed by Margaret James
Fact checked by Vikki Velasquez

Even people who have never paid into the Social Security system may be eligible for spousal benefits if they are married (or were formerly married) to someone who has contributed to it. In some instances, they may also be able to apply for retroactive benefits.

Key Takeaways

• Social Security spousal benefits are available to people whose spouses paid into the Social Security system, even if they never did so themselves.
• Spouses who apply at their full retirement age may be eligible for a benefit equal to 50% of the other spouse’s benefit.
• If spouses wait past their full retirement age to apply, they may be eligible for up to six months’ worth of retroactive benefits, in the form of a lump-sum payment.

How Retroactive Benefits Work

Retroactive benefits are a one-time payment that the Social Security Administration (SSA) can make to people who delay filing for retirement benefits beyond their full or “normal” retirement age (66 for many, 67 for those born in 1960 or later).

In other words, if you file for benefits after you’ve reached your full retirement age, you can request a retroactive benefit to reimburse you for the monthly payments you’ve missed. However, the most you can receive is six months’ worth of benefits.

For people who are filing for regular, non-spousal retirement benefits, there is a tradeoff. By filing for retroactive benefits back to the month they reached full retirement age, they lose the delayed retirement credits they would otherwise have earned. With spousal benefits, however, delayed retirement credits don’t apply, so there is no downside to requesting a retroactive benefit.

What Is Social Security?

Social Security is the Old-Age, Survivors, and Disability Insurance (OASDI) program in the United States. It’s run by the Social Security Administration (SSA), a federal agency. It’s best known for retirement benefits, but it also provides survivor benefits and income for workers who become disabled.

Has Social Security Always Offered Spousal Benefits?

No. Social Security was created in 1935, but spousal benefits were not offered until 1939. Wives could collect such benefits then, but husbands did not begin collecting such benefits until 1950. The Social Security Administration began offering spousal benefits for same-sex married couples in 2015, after the U.S. Supreme Court ruled that same-sex couples have a constitutional right to marry.

What Are the Maximum and Minimum Social Security Spousal Benefits?

You are entitled to up to 50% of the amount your spouse is eligible to receive at their full retirement age. You could also receive as little as 32.5% if your spouse files for benefits before full retirement age.

The Bottom Line

If you’ve waited to apply for Social Security spousal benefits past your full retirement age, you may be eligible for a retroactive payment. That said, the simplest way to apply for spousal benefits is to do so at your full retirement age and start collecting them right away.

Because retroactive benefits are a relatively obscure option, it’s best to seek out a knowledgeable counselor at your Social Security office for guidance.

Reviewed by David Kindness
Fact checked by Vikki Velasquez

The internal rate of return (IRR) is frequently used by companies to analyze profit centers and decide between capital projects. But this budgeting metric can also help you evaluate certain financial events in your own life, like mortgages and investments.

The IRR is the interest rate (also known as the discount rate) that will bring a series of cash flows (positive and negative) to a net present value (NPV) of zero (or to the current value of cash invested). Using IRR to obtain net present value is known as the discounted cash flow method of financial analysis.

Key Takeaways

• The internal rate of return (IRR) is the interest rate that will bring the net present value of a series of cash flows to zero.
• Corporations use IRR to estimate the present value of future cash flows from a potential investment.
• IRR calculations can be very complex, but can easily be calculated using accounting software or spreadsheet programs like Excel.

Uses of Internal Rate of Return (IRR)

As we mentioned above, IRR is a key tool in corporate finance. For example, a corporation will evaluate investing in a new plant versus extending an existing plant based on the IRR of each project. In such a case, each new capital project must produce an IRR that is higher than the company’s cost of capital. Once this hurdle is surpassed, the project with the highest IRR would be the wiser investment, all other things being equal (including risk).

IRR is also useful for corporations in evaluating stock buyback programs. Clearly, if a company allocates a substantial amount to a repurchasing its shares, the analysis must show that the company’s own stock is a better investment—that is, has a higher IRR—than any other use of the funds, such as creating new outlets or acquiring other companies.

Calculation of Internal Rate of Return (IRR)

The IRR formula can be very complex depending on the timing and variances in cash flow amounts. Without a computer or financial calculator, IRR can only be computed by trial and error. The Excel IRR function can help you accomplish this task much easier.

One of the disadvantages of using IRR is that all cash flows are assumed to be reinvested at the same discount rate, although in the real world, these rates will fluctuate, particularly with longer-term projects. IRR can be useful, however, when comparing projects of equal risk, rather than as a fixed return projection.

The general formula for IRR that includes net present value is:

$begin{aligned} 0 &= CF_0 + frac{CF_1}{(1 + IRR)} + frac{CF_2}{(1 + IRR)^2} + dotso + frac{CF_n}{(1 + IRR)^n} \ &= NPV = sum^N_{n = 0} frac{CF_n}{(1 + IRR)^n} \ &textbf{where:}\ &CF_0=text{Initial investment/outlay}\ &CF_1, CF_2, dotso, CF_n=text{Cash flows}\ &n=text{Each period}\ &N=text{Holding period}\ &NPV=text{Net present value}\ &IRR=text{Internal rate of return}\ end{aligned}$0​=CF0​+(1+IRR)CF1​​+(1+IRR)2CF2​​+…+(1+IRR)nCFn​​=NPV=n=0∑N​(1+IRR)nCFn​​where:CF0​=Initial investment/outlayCF1​,CF2​,…,CFn​=Cash flowsn=Each periodN=Holding periodNPV=Net present valueIRR=Internal rate of return​

Warning

IRR calculations do not account for the riskiness of a proposed investment.

Example of Internal Rate of Return Calculation

The simplest example of computing an IRR is by taking one from everyday life: a mortgage with even payments. Assume an initial mortgage amount of $200,000 and monthly payments of $1,050 for 30 years. The IRR (or implied interest rate) on this loan annually is 4.8%.

Because the stream of payments is equal and spaced at even intervals, an alternative approach is to discount these payments at a 4.8% interest rate, which will produce a net present value of $200,000. Alternatively, if the payments are raised to, say $1,100, the IRR of that loan will rise to 5.2%.

Here’s how the above formula for IRR works using this example:

• The initial payment (CF₁) is $200,000 (a positive inflow)
• Subsequent cash flows (CF₂, CF₃, CF_n) are negative $1,050 (negative because it is being paid out)
• Number of payments (N) is 30 years x 12 = 360 monthly payments
• Initial Investment is $200,000
• IRR is 4.8% divided by 12 (to equate to monthly payments) = 0.400%

Internal Rate of Return and the Power of Compounding

IRR is also useful in demonstrating the power of compounding. For example, if you invest $50 every month in the stock market over a 10-year period, that money would turn into $7,764 at the end of the 10 years with a 5% IRR, which is more than the current 10-year Treasury (risk-free) rate.

In other words, to get a future value of $7,764 with monthly payments of $50 per month for 10 years, the IRR that will bring that flow of payments to a net present value of zero is 5%.

Compare this investment strategy to investing a lump-sum amount: to get the same future value of $7,764 with an IRR of 5%, you would have to invest $4,714 today, in contrast to the $6,000 invested in the $50-per-month plan. So, one way of comparing lump-sum investments versus payments over time is to use the IRR.

Internal Rate of Return and Investment Returns

IRR analysis can be useful in dozens of ways. For example, when the lottery amounts are announced, did you know that a $100 million pot is not actually $100 million? It is a series of payments that will eventually lead to a payout of $100 million but does not equate to a net present value of $100 million.

In some cases, advertised payouts or prizes are simply a total of $100 million over a number of years, with no assumed discount rate. In almost all cases where a prize winner is given an option of a lump-sum payment versus payments over a long period of time, the lump-sum payment will be the better alternative.

Another common use of IRR is in the computation of portfolio, mutual fund or individual stock returns. In most cases, the advertised return will include the assumption that any cash dividends are reinvested in the portfolio or stock. Therefore, it is important to scrutinize the assumptions when comparing returns of various investments.

What if you don’t want to reinvest dividends, but need them as income when paid? And if dividends are not assumed to be reinvested, are they paid out or are they left in cash? What is the assumed return on the cash? IRR and other assumptions are particularly important on instruments like whole life insurance policies and annuities, where the cash flows can become complex. Recognizing the differences in the assumptions is the only way to compare products accurately.

What Are the Problems With Internal Rate of Return?

The internal rate of return can sometimes give a distorted view of capital returns, especially when viewed without considering the context of each investment. One major assumption is that any interim cash flows from a project can be invested at the same IRR as the original project, which may not necessarily be the case. In addition, IRR does not account for risk—in many cases, investors may prefer a project with a slightly lower IRR to one with high returns and high risk.

What Is a Good Internal Rate of Return?

There’s no fixed rule for what makes a “good” internal rate of return, except that a company’s IRR for a project should exceed its cost of capital. Typical returns from a capital investment will vary depending on the industry and the type of investment. Using the real estate industry as a very general example, an IRR of 10% would be acceptable for very conservative projects, while risky ones might require an IRR greater than 20%.

What Does Internal Rate of Return Tell You?

The internal rate of return tells you how much a project or investment needs to make in order to break even, accounting for the cost of capital and the net present value of future cash flows. In other words, it is the interest rate that makes the present value of the expected income streams equal to the cost of the investment.

The Bottom Line

As the number of trading methodologies, alternative investment plans, and financial asset classes has increased exponentially over the last few years, it is important to be aware of IRR and how the assumed discount rate can alter results, sometimes dramatically.

Many accounting software programs now include an IRR calculator, as do Excel and other programs. A handy alternative for some is the good old HP 12c financial calculator, which will fit in a pocket or briefcase.