At Christy Capital, we get frequent questions about Social Security benefits.
One situation we’re often asked about is what happens if you retire in your 50s before you are eligible to begin receiving Social Security benefits? (Currently, the earliest you can get Social Security benefits is age 62.)
The Social Security Administration operates with the assumption that everyone will work up until the age they can “turn on” their benefits. But some people want to leave the workforce before they are actually eligible—before age 62. What happens then?
How Social Security calculates your benefits
Visit the Social Security website, and you’ll see that they determine your retirement age as the age that you start receiving Social Security benefits. For some people, however, this is not when they retire. Many retire before the age of 62.
So, how does Social Security determine retirement benefits? It’s based on two factors: (a) your highest 35 years of earnings; and (b) the age you start receiving benefits.
If you stop working prior to receiving benefits and you have less than 35 years of earnings, your benefit amount will be affected. When calculating the amount of retirement benefits that you are due, Social Security will use a zero for each year you have no earnings. It will average those zeroes with your earnings from other years, resulting in a lower benefit. In short, those years with no earnings reduce your retirement benefit amount.
And even if you have the required 35 years of earnings once you stop working, some of those years may be low earning years. When you file for retirement benefits, those low-earning years will be averaged into your calculation creating a lower benefit as well. However, had you continued to work, your lower income years would have been replaced by higher earning years. Those higher earnings would then increase your benefit amount.
That’s a quick overview of the two factors that determine how much Social Security you’re going to get. Now, let’s look at them in more detail.
Factor #1: When you turn on Social Security benefits
The first determinant of how much you’ll receive from Social Security is when you start receiving benefits. Let’s say you were born in 1960 or later. Your full retirement age is age 67. For every month you retire before age 67, Social Security will reduce your maximum monthly benefit 5/9 of 1%. There are 60 months in the five years between early retirement age (62) and full retirement age (67). Therefore, retiring at age 62 equates to a 30% reduction from what your full benefit would’ve been if you’d waited till full retirement age.
On the other hand, if you elect to not take Social Security benefits until after full retirement age—say, for example, you waited until age 70—there would be an 8% increase added for each year past full retirement age that you delayed benefits.
So, the first factor that determines your benefit is when you turn on Social Security benefits. What age are you when you begin receiving payouts?
Factor #2: Your earnings history
As stated above, Social Security looks at your highest 35 years of earnings. If you only have 25 years of earnings, then there will be ten years of zero income. That would obviously bring down your average! On the other hand, if you do have 35 years of earnings, but you work an additional year at a higher income, that replaces a year of lower income.
My first years of working were at Subway back in high school. So, if I work an extra year making more money, the low wages I earned one of those years making sandwiches would drop off.
This is one of the problems with retiring early. You won’t have higher earning years to take the place of those low-earning years. Or, worse, if you retire so early you don’t have 35 years of earnings, then you’ll have zeros factored in.
Again, the assumption Social Security makes is that you’re going to work to age 62, then retire and start receiving benefits. When they show you the age 67 amount, they’re assuming you’re going to work until the age of 67 and then turn it on. For those future years leading up to that retirement time, they estimate income similar to what you have now.
So, if you retire before 62, is this a huge deal?
Possibly.
The importance of financial planning
What you need is a comprehensive financial plan. It’s important to factor in all of your income sources. Maybe you have a pension, maybe there’s a spousal Social Security benefit. We need to get a good estimate for your Social Security benefit based on when you plan to retire.
Then we need to ask other questions: What other assets do you have? What type of lifestyle are you wanting to live in retirement? Exploring all these issues will let us know what kind of retirement you can expect.
So, it is important to get a good estimate of what your Social Security will be. If all the math works and the financial plan says you have enough money, then it’s not necessary to work extra years just to get a little bit more Social Security. You can retire before age 62.
If we can show that you have enough money and are able to retire, anything additional is a bonus. Feel free to work longer if that’s what you want to do or feel like God is calling you to do. But if you have enough and you want to retire, don’t keep working just to get a little bit more Social Security.
Working an extra four years for the sole purpose of getting just a little bit more Social Security may not make sense depending on what the rest of your numbers look like.
Take the mystery out of retirement
If you need help wrestling with all these questions, or if you’ve never created a comprehensive financial plan, our team at Christy Capital Management would love to assist you.
Give us a call at (866) 331-7749. Or click that “Talk with an Advisor” button.
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