Early retirement is a goal for many Americans but accessing Social Security prematurely can cost retirees thousands of dollars annually. There are some important reasons to consider waiting until you are 67 or older before tapping into your Social Security benefits, even if you plan to stop working and retire well before then.

The Basics

There are two primary factors to consider when you decide when to access your Social Security benefits:

First, how much you are entitled to in benefits after years of working and contributing into the system.
Second, the impact of any penalties or credits you are due for early or delayed receipt of your benefit payments.
Other sources of Retirement Income

Social Security benefits accrued are calculated based on the 35 years when you earned the most over the course of your career. The average income over this period, adjusted for inflation, is used to determine the amount of your monthly payments when you begin receiving them.

Deciding When to Start

Currently, full retirement age is 67 for anyone born after 1960. People born prior to 1960 are fully vested at a younger age, with the earliest possible starting point of 66 years, 2 months for anyone born in 1955 or earlier. The earliest that a retiree can receive benefit payments is age 62 but recipients are penalized for accessing funds prior to full retirement age. You can also delay the start of benefit payments until age 70 and earn credits for the years deferred, increasing the payments that you ultimately receive. In short, the monthly Social Security payments you receive will be reduced if you access them before full retirement age and increased if you delay receiving them until later.

At age 70 any advantages to delaying payments end. Delaying beyond age 70 (by forgetting to apply) means you will actualy lose some benefits entirely. Everyone should access their benefits by age 70!

Who Gets What?

Like a private pension, the SSA calculates your benefits as a replacement for the income no longer received after you stop working. The Average Indexed Monthly Earnings (AIME) determined by the SSA is a monthly average of what you earned over the course of the 35 years that you had the highest income levels. These years need not be consecutive, so a retiree who leaves the workforce for a period due to family commitments or other factors will not be penalized so long as they contribute for 35 years in total.

If you are working and have been paying into the program, you should receive periodic updates from the Social Security Administration (SSA) to tell you what benefits you can anticipate receiving when you retire. It is important to understand that if you have not yet contributed for 35 years, the numbers in those statements are projections that assume you will continue to work and earn an amount similar to what you have thus far.

If you contribute to Social Security for fewer than 35 years, a zero will be used to represent each year that you did not work. Therefore, failing to work for 35 years has a huge impact on the calculation of AIME, potentially making retirement before that milestone much more expensive in terms of lost benefits since they will be calculated from a lower starting point.

The monthly replacement amount calculated for you is called the Primary Insurance Amount (PIA). Currently the SSA calculates your PIA by combining 90% of the first $885 of your AIME, 32% of the next $4,651 per month, and finally 15% of any additional monthly earnings up to a hard cap of $127,200 per year. Thus, the percent of AIME received in benefits is greater for lower earners and declines for those whose average earnings were higher.

Your PIA will be reduced by 6.66% for each year after you turn 62 that you access benefits before reaching full retirement age. If you decide to wait beyond full retirement age to receive payments, your PIA will be bumped up by 8% for each year that you wait up until your 70th birthday.

Example

Scenario 1: If a retiree born after 1960 achieved an average annual income of $120,000 over the course of their highest earning 35 years, the amount of benefits due at age 67 would equal $2,952 per month (90% of $882, 32% of the next $4,651 and 15% for the remaining $4,467 average monthly income) or just less than 30% of the AIME.

Scenario 2: If the same investor elected to start receiving benefit payments at the earliest age possible, 62, the total benefits received monthly would be reduced by a factor of 6.66% multiplied by 4 years or a reduction of 26.4%. That would reduce monthly benefits from $2,952 to $2,173.

Scenario 3: If the investor in this example opted to delay receipt of benefit payments until age 70, the total benefits received monthly would be increased by 8% multiplied by 3 years or an increase of 24%. This would increase total monthly benefit payments from $2,952 to $3,660.

As illustrated in the above example, the decision to access your Social Security benefits early will dramatically reduce your monthly income levels in future years.

Working During Retirement

A person who continues to work part time while receiving benefits early may be subject to a reduction in monthly payments based on how much they earn. For those working for a full year while accessing benefits prior to their full retirement age, benefits will be reduced by one half of all earnings beyond $17,640. A different, lower reduction calculation is applied during the year that a worker receiving benefits reaches full retirement age. After full retirement age is reached, there are no further reductions of benefit payments.

Retirement Planning for Government Employees & Military

Many federal, state and local government employees receive reduced benefits from the SSA including postal workers, first responders, and teachers. This lower payment formula is called the Government Pension Offset (GPO) and will potentially impact the retirement planning of any civil servant or their spouse who is entitled to a pension through their work. Any public sector employee with pension benefits should carefully consider the impact of GPO. Military retirement benefits are not subject to GPO but there are other important considerations for retired military personnel to consider for retirement.

The Price of Independence

As the US economy continues to evolve, many professionals find themselves working as independent contractors through choice or circumstance. In addition to income tax, Social Security, and Medicare contributions, an independent worker is subject to self-employment taxes, meaning that they pay the portions contributed by both the employer and employee to the SSA or 15.3% in total. Retirement planning for the self-employed is a complex process with significant potential pitfalls and opportunities.

When One Spouse Remains Home

Often a married couple will divide employment and family commitments in a manner which limits the ultimate Social Security benefits realized by the partner who works in the home providing primary care for children or elderly parents. In this situation, careful consideration of future benefits available to the caregiver spouse should be factored into household retirement planning - see Spousal Benefits

Look at the Bigger Retirement Picture

As you can likely tell by now, calculating your benefits is challenging enough but only the start. You need to look at your entire retirement picture to make the final decision about when to start your benefits. You should look at your health, your investment portfolio, your other income sources, and many other factors specific to your personal situation.

The best way to do this is to contact a fiduciary financial advisor near you. We help our clients everyday make decisions like this, around social security, their investments, tax planning, and every other part of their comprehensive financial plan. Schedule a call with one of our advisors today!

Social Security Benefits - Calculating the Full Cost Retiring Early