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Understanding Social Security and When to Take Your Benefits

When planning for retirement in the United States, Social Security is the common denominator for the vast majority of workers. After spending your working life paying into the system, being eligible to collect Social Security benefits is one of the hallmarks of American retirement.

Social Security is a federally-run insurance program that provides retirement benefits, survivor benefits, and disability income to provide economic security for millions of Americans each year. As of June 2019, approximately 64 million people received monthly Social Security benefits, about 48 million of whom were retirees and their families.

Retirees can start collecting a reduced benefit at 62. After working forty plus years, it can be tempting to start enjoying guaranteed monthly income as soon as you are eligible. However, there are tradeoffs to collecting early and many workers may benefit by waiting a few years to begin collecting.

Who Can Take Social Security Benefits?

Social Security benefits are available to older Americans, workers who become disabled, and families who experience the loss of a spouse or parent. Rules around collecting benefits for the loss of a parent or for disability are too complicated to address in a short article. If either situation applies to you, I recommend working with your Financial Advisor and/or contacting the appropriate benefit specialists at the Social Security Administration (SSA). For the average retiree, who is the most common beneficiary of Social Security, the rules are much easier to understand.

To qualify for Social Security payments, you or your spouse must have paid the Social Security payroll tax for at least 10 years over your working history. Nonworking spouses can be eligible to collect up to half of the working spouse’s benefit.

Your 35 highest-earning working years, indexed for inflation, are used to calculate your benefits. There is a limit to the amount of annual income that qualifies for the Social Security calculation ($137,700 for 2020). In general, higher earners can expect to receive more in benefits from Social Security.

When Am I Eligible to Collect Benefits? 

Retirees can begin collecting as early as 62 or as late as 70 (even earlier as a survivor of another Social Security claimant or with a disability).

Full retirement age depends on your birth year:

Year of Birth

Full Retirement Age (years)

1943-1954

66

1955

66 and 2 months

1956

66 and 4 months

1957

66 and 6 months

1958

66 and 8 months

1959

66 and 9 months

1960 or later

67

Early retirement.

Your Social Security monthly benefits are permanently reduced by five-ninths of 1% for every month you start getting benefits up to 36 months before your full retirement age. If you begin claiming more than 36 months before your full retirement age, your benefit is further reduced by five-twelfths of 1% for each additional month. Your benefits do not increase once you reach full retirement age. If your full retirement age is 66 and eight months, and you begin collecting Social Security at age 62, you would only get about 71.7 percent of your full benefit.

Delayed or late retirement.

Delaying beginning your benefits past your full retirement age results in an increase of 2/3 of 1% per month (8% a year) in your monthly benefits for each month you delay until age 70, when benefits cap out. According to the SSA, your monthly benefit will be roughly 24-32% higher than if you began collecting at full retirement age and a whopping 76% higher than if you begin claiming at 70 instead of at 62. You can use the SSA’s Early or Late Retirement? calculator to see the effect on your benefits of retiring at various ages.

When is the Best Time to Start My Benefits?

The decision of when to start collecting Social Security benefits is highly personal. In deciding when to begin taking your Social Security benefits, you should consider:

  • Current employment. Earned income (including self-employment income) can reduce your benefit. If you are working and collecting Social Security benefits prior to full retirement age, $1 in benefits is deducted for every $2 you earn above the annual limit ($18,240 for 2020). The reduction in benefits falls to $1 in benefits for every $3 you earn above a much higher annual limit ($48,600 for 2020) in the year you reach full retirement age.
  • Your healthcare. While you can begin drawing reduced Social Security benefits at 62, Medicare eligibility is set to 65. If you do not have employer-sponsored health insurance through your employer or your spouse’s employer, private health insurance will wipe out a large portion of your Social Security payments each month.
  • Your life expectancy. According to the SSA, average life expectancy for an individual turning 65 years old on April 1, 2020 is about 84 years for males and 86.5 for females. You can use the SSA’s life expectancy calculator to see the average life expectancy for an individual of your gender and date of birth. Of course, the calculator does not take into account your lifestyle, family and personal health history, education, and other factors that can affect your life expectancy. If you are in good health, the higher benefits over 20+ years may outweigh the benefits of early payments. If you are in poor health, immediate access to guaranteed income from Social Security may be the right choice in some circumstances.
  • Your spouse. Married couples live longer on average than single folks and have an above average probability of one or both spouses living to 90. Many couples do the math and find that waiting to have the higher earning spouse claim benefits as long as possible, up to age 70, is the best choice for their situation. The lower income spouse may be able to claim earlier, depending on the couple’s finances. After the death of one spouse, the surviving spouse receives the larger of the two benefits for his or her lifetime. For couples with a large difference in average earnings over the course of their careers, this can make a significant difference in the financial health of the surviving spouse.
  • Current cash needs. Do you have an alternate means of income? Working longer or drawing on other retirement accounts can help you maximize your monthly benefits.

How Can I Maximize My Benefits?

You can increase your monthly benefit amount in two ways:

  • Keep working. If you have less than 35 years of income history, each additional year you work replaces a zero-income year in the calculation for your benefits. If you’ve worked a full 35 years but have moved up the company ladder, another year at your current income can edge out a lower income year from earlier in your career.
  • Collect later. Beginning your benefits at age 62 results in a permanently reduced monthly benefit while delaying to age 70 yields the highest possible monthly benefit. Talk with your financial advisor about what your break-even age is for delaying beginning Social Security benefits. The break-even age will vary depending on what your tax assumptions are and the opportunity cost of waiting. In general, if you think you will beat the average life expectancy or if you are the higher earning spouse and want to maximize survivors benefits for your spouse, waiting to claim benefits may be the better option. If you are in poor health or are the lower income spouse (and your partner can delay beginning benefits), claiming earlier may make more senses for your situation.

Is Social Security Enough for Retirement?

Social Security was never meant to be the sole source of income for retirees. The average monthly benefit as of January 2020 was $1,503. The maximum monthly benefit for someone retiring at full retirement age in 2020 is $3,011. Social Security claimants receive modest cost-of-living adjustments (COLA) based on inflation each year, ranging from 0-3.6% over the past decade. The 2020 COLA was 1.6% and a similar COLA is expected for 2021.

Wondering if Social Security will still be around by the time you retire? You may have heard that Social Security is funded by current workers and the coming retirements of baby boomers could overwhelm the system. As of June 2019, about 177 million people worked and paid Social Security taxes. According to the SSA’s 2020 Annual Report, the Social Security Trust fund has enough resources to cover all promised retirement benefits until 2035 and will cover 79% of scheduled benefits for new retirees after 2035 without changing the current system.

While planning for retirement, it may be best to think of Social Security as a form of insurance, not as a primary income source for your golden years. Most financial advisors recommend that your retirement income needs to replace 70-80% of your pre-retirement income for a comfortable lifestyle throughout your golden years.

The amount of pre-retirement wages that Social Security benefits replace varies based on what your average earnings were and when you chose to begin collecting. The maximum yearly benefit for an individual collecting at the full retirement age in 2010 comes to $36,132. For many retirees, this is too little to support their desired lifestyle.

Don’t leave taxes out of your retirement calculations – about 40% of current Social Security beneficiaries pay taxes on their benefits. Filing as an individual on your federal tax return, you may have to pay taxes on your benefits if your total income exceeds $25,000 ($32,000 for couples filing jointly).

Your retirement plan should take into account your investments, savings, and Social Security benefits to provide the retirement income you need to support you throughout your golden years. A trusted Financial Advisor like our team at Ridgewood Investments will help you prepare your portfolio to provide the income you need in retirement so you can spend less time worrying about Social Security benefits and more time planning the hobbies, travel, or other goals you plan to pursue in retirement.

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About the Author

Kaushal “Ken” Majmudar, CFA founded Ridgewood Investments in 2002 and serves as our Chief Investment Officer with primary focus on managing our Value Investing based strategies. Ken graduated with honors from the Harvard Law School in 1994 after being an honors graduate of Columbia University in 1991 with a bachelor’s degree in Computer Science. Prior to founding Ridgewood Investments in late 2002, Ken worked for seven years on Wall Street as an investment banker at Merrill Lynch and Lehman Brothers where he has extensive experience working on initial public offerings, mergers and acquisitions transactions and other corporate finance advisory work for Fortune 1000 companies. He is admitted to the bar in New York and New Jersey though retired from the practice of law.

Ken’s high level experience and work with clients has been recognized and cited on multiple occasions. He is a noted value investor who has written and spoken extensively on the subject of value investing and intelligent investing. He has been a member of the Value Investors Club – an online members-only group for skilled value investors founded by Joel Greenblatt, SumZero – an online community for professional investors, and has also written for SeekingAlpha – among others. Ken is active in leading professional groups for investment managers as a member of both the CFA Institute and the New York Society of Securities Analysts.