Retirement. Perhaps not as inevitable as death or taxes, but potentially much more pleasant. For those looking forward to this milestone, questions abound. Some of those questions will likely concern your expected Social Security benefits.
More than $1 trillion in Social Security benefit payments are made each year. These payments make up about one-third of all elderly income in this country. Social Security has helped reduce the number of senior citizens living in poverty from 50% at the program’s inception to 10% today. Many retirees depend on this program for most of their income. Whether this will be true for you or not, if Social Security benefits are part of your retirement planning, understanding how the program works will help you make good decisions.
A question faced by everyone heading toward retirement age is when they should file for Social Security benefits. Finding the answer is more complex than it seems. You have essentially three choices, and the best answer for you is not necessarily the correct answer for someone else. Your answer is important, and permanent; once you begin to receive checks, there are no mulligans.
To help with this decision, let us first take a closer look at how the Social Security Administration calculates benefits. The amount of your monthly benefits is based on your Average Indexed Monthly Earnings or AIME. The government calculates your AIME by averaging your highest earning 35 years of annual income, indexed for inflation and capped at the maximum taxable income for FICA taxes ($132,900 in 2019). It then divides this indexed average annual income by 12 to get a monthly income.
Your AIME is then run through a formula to calculate you Primary Insurance Amount (PIA). The formula always uses the same percentages, but the cutoff points change annually. At the time of this writing the PIA formula looks like this:
- 90% of AIME of the first $895; plus
- 32% of AIME greater than $895 but less than $5,397; plus
- 15% of AIME greater than $5,397.
For example, if you averaged $60,000 per year for your entire working life and turned 62 in 2019, your AIME would be $5,000. The Social Security Administration would calculate your benefits as follows:
- 90% of $895 = $805.50; plus
- 32% of $4,105 = $1,313.60; plus
- 15% of $0 = $0
- Your benefits would be $2,119.10 per month.
However, if you file for benefits before your normal retirement age, that amount would be greatly reduced. Retiring at age 62 will permanently reduce the amount of your benefits by over 25%.
A Cost of Living Adjustment (COLA) is applied by the government to keep benefits current with the rate of inflation. It is also the figure used to adjust your benefits based on retirement age.
There is a maximum monthly amount that someone can collect. For a person retiring in 2019 at full retirement age, the maximum amount is $2,861. By waiting until age 70, that same person would collect $3,770 per month, the maximum a person can receive in 2019.
If you won’t be collecting the maximum amount, there are things you can do to increase your monthly payments. The obvious one is to delay filing for benefits. Waiting until full retirement age (66 or 67 depending on when you were born) will avoid the early retirement penalty. Your benefits will increase by 8% per year until age 70 if you can put off filing until then. A guaranteed 8% return is outstanding, and something to take advantage of if possible.
Delaying your retirement is also likely to increase your AIME. Since only the highest earning 35 years are used in the calculation, replacing some low-earning years from early in your working life with higher-earning ones will boost your average monthly earnings. This is especially important if you did not work in any of your top 35 years; you get credit for $0 earned in each missing year. Averaging in zeros will drag down your AIME in a hurry.
You can continue to work after filing for benefits, although this may reduce your current benefits if you are younger than full retirement age. For early retirees, earning over $17,640 in 2019 will lower your benefits by $1 for $2 earned above the cap. The earnings limit increases to $46,920 in the year you reach full retirement age, with benefits reduced by $1 for every $3 earned above the limit. After reaching full retirement age, the earnings limit goes away, as does the benefit reduction.
If you continue working after filing for benefits, and you are increasing your net highest 35-year earnings, you will also be raising your AIME. The Social Security Administration will recalculate your AIME as new information becomes available. Continuing to work has the added bonus of enabling additional contributions to your IRA, 401(k), or other retirement plan.
For a married person whose spouse earned significantly more than they did, spousal benefits may increase their Social Security income. In this case you can claim Social Security payments up to half of your partner’s benefit amount. If you survive your higher earning spouse, you are entitled to their full benefit payment. This would not stack with any existing benefits, however. Finally, the “File and Suspend” strategy is no longer a viable option. Congress closed this loophole in 2015.
So which option should you choose? Do you take reduced retirement benefits by retiring early, wait until full retirement at age 66 or 67, or further delay benefits until later, up to age 70? One way to tackle this question is to calculate your “break even” age. This is the age at which you would come out ahead by delaying your benefits. Generally speaking, one would need to live to age 77 or 78 to make waiting until full retirement age pay off versus retiring at 62, and to age 80 versus retiring at age 70. One would need to live to age 82 or 83 to make retiring at age 70 pay off versus retiring at full retirement age.
The average life expectancy for men in this country is 76 and is 81 for women. Of course, those are just averages, and making the “right” choice depends on you making a fairly accurate guess about your own lifespan.
Even if you expect to live well past the average age, it may be that you need the income before your age of full retirement. Check with your financial advisor before filing for Social Security benefits. It may be that drawing from other retirement sources would be more valuable than filing early for Social Security.
There are two other common reasons given for taking early retirement. One is the rationale that you could invest your Social Security benefits and avoid leaving money on the table if you were to die early. However, to match the rate of return you would get by waiting, you would likely need to invest most of the funds in stocks, which would subject you to market fluctuations without the long-term ability to recover your losses. You would also need to avoid the temptation to spend the income.
Others are concerned that Social Security won’t be around when they retire or will be paying reduced benefits. While the trust fund is expected to have a shortfall in 2034, that still gives Congress 15 years to come up with a solution.
If you don’t need the income early, most financial planners suggest waiting as long to possible before filing for Social Security benefits. Be sure to check with your advisor before making this important decision. 8