US News lists five ways you could be sabotaging your retirement but I want to share and comment on just two of them. Here's the first:
Not negotiating better pay during the hiring process. In this economy, it's easy to be grateful for even having a job. But you are definitely short changing yourself if you don't negotiate for higher pay once an employer presents a job offer. A higher starting salary sets you up for bigger paychecks down the line because most raises are calculated as a percentage of your current pay. The worst an employer can say is no. And unless you are very rude in your negotiations, it’s highly unlikely that an employer will take their original offer back because you asked if there is any room for improvement.
Not only does this hurt you at retirement, it hurts EVEN more during the course of your career. The difference between someone who works at maximizing their income (by delivering excellent performance, asking for raises, getting promotions, etc.) and someone who doesn't is literally millions of dollars over a working lifetime. For specifics on the numbers, check out How to Maximize Your Lifetime Earnings.
Working less than 35 years. You could be drastically cutting your Social Security checks without even knowing it if you decide to retire early. Your Social Security checks will be based on your 35 highest annual salaries. If you work less than 35 years, you get a zero averaged in for each year that you didn’t work. And it’s usually a good idea to work even more than 35 years to cancel out unfortunate years that you didn't work much due to layoffs or your lower salary at the beginning of your career.
First off, is this true? I assume it is since it's from US News, but does anyone know for sure? It's new news to me.
Second, I'm not planning on anything from Social Security as I plan retirement (then if I get something, it will all be gravy), but if I want to max out any potential earnings, that means I have 12 years of work ahead of me. Ugh. I was thinking more like five to seven years before early semi-retirement.
Third, those of you who have retired early -- have you taken this into account in your retirement plans?
I hadn't heard that about having a 0 average in for social security for the years not worked up to 35. I guess it makes sense if benefit is based on 35 years of working.
I am like you, I don't count on social security either. Based on my recent third quarter statements, doesn't look like I can count much on my 401k either. :)
Posted by: Kris @ Everyday Tips and Thoughts | October 19, 2011 at 08:26 AM
Useful information on social security at this link: http://www.ssa.gov/planners/faqs.htm
I've heard that you are entitled to social security benifits of your spouse if and only if you have been married at least ten years. Divorcees are also entitled if the divorce occured after 10 years of marriage.
Posted by: Luis | October 19, 2011 at 08:54 AM
The 35 years average is correct including zeros. Just keep in mind the benefit payout is not a directly porportional relationship to your income (each additional dollar of earnings adds an incrementally lessor amount to your benefit), so missing a few years doesn't hurt as much as it would seem. (e.g. If you worked 35 years and averaged $50K your benefit would be around $1300. If you didn't work 10% of those years your income average would drop 10%, but your benefit would only drop about 6%).
If one wanted to "max out" potential earning from all sources until retiring then one wouldn't retire until eventually unable to work. An early retiree is not looking to max out earnings, they are looking to max out years of retirement on "enough" earnings.
Posted by: Strick | October 19, 2011 at 09:02 AM
I took early semi-retirement at age 40 because I knew if I kept working full-time, I might not make it to age 50. There are things more important than being the richest person in the graveyard.
Posted by: Cara | October 19, 2011 at 09:07 AM
The 35 years is correct.
Social Security payments are based on your Average Indexed Monthly Earnings (AIME)
http://www.ssa.gov/oact/cola/Benefits.html
When determining someone's AIME income is indexed for inflation. So income earning in your early years will be adjusted up based on inflation and make them a larger contribution than they might appear. However this indexing formula is put in place in the year you turn 60. That means all income you contribute prior to turning 60 is indexed for inflation when determining your AIME but all income earned after that is not. The link below shows two examples of calculating a person's AIME. You will notice in the second example that the years after age 60 the indexing in the table was 1.000 so not inflation adjustment was applied.
The fact that only 35 years count towards your benefit and that after age 60 the income is not adjusted for inflation when calculating the AIME is one reason why income earning in those years likely has very little if any affect on many peoples social security checks unless you had a number of years with very little income. If you started working at age 22 you already have 38 years under your belt by age 60 so you are already throwing 3 of them away anyway.
http://www.ssa.gov/oact/ProgData/retirebenefit1.html
Based on the AIME there is a formula used to calculate your Primary Insurance Amount (PIA). This is the amount of your monthly check. This is a graduated formula that gives larger payouts for smaller contributions.
http://www.ssa.gov/oact/cola/piaformula.html
The percentages in this formula do not change but the dollar amounts are adjusted every year based on inflation. Currently the formula is the following:
90 percent of the first $767 of AIME
+ 32 percent of AIME earnings over $767 and through $4,624
+ 15 percent of AIME over $4,624
Adding those values will give you your monthly social security check.
The 15 percent "bracket" starts at about half way to the point of the maximum AIME if you had paid the maximum social security for all 35 years. So you can see based on this formula that once you have contributed about half the maximum that you could contribute to social security the amount that it is increasing your benefit is minimal.
I personally intend to leverage that fact as I am probably approaching the half way point with about 19 years of contributions, not all at the max but near the upper end. I hope to leave wage income in the next few years and transition to rental income which considered unearned and is thus not taxed for FICA. I will have made enough contributions to social security to maximize both the 90% and 32% parts of this formula even though I will not have worked for 35 years. Thus I will still have earned about 3/4 of the maximum size of a social security check that I could get if I continued contributing to social security up until I was 62.
I won't miss making that contribution one bit and it won't cost me hardly anything in lost retirement earnings either. Further more if they means test social security in the future it is likely to hit those contributing the max more so than those with more meager contributions. Most proposal for means testing talk about just reducing how much earnings they count towards your social security check rather than outright eliminating it for higher income or net worth individuals. Likely changes to means test social security will probably just make the 15% bracket an even smaller percentage or make it start even quicker while increasing the percentages of the other two brackets. Thus if you are high income and contributing in those years of 20-35, there is a good chance that eventually, most or all of those contributions will be throw away if they put in place a more aggressive means testing formula.
So in my opinion, the argument to make sure to get 35 years of contributions into social security does not hold much truth if you are contributing anywhere near the max. If you are contributing at a much lower level then it certainly is true.
If you contribute to SS for 40 years only your 35 highest years are counted. The other 5 are thrown away completely. They are literally contributions that are wasted or lost.
Secondly all earnings that are counted for SS prior to the age of 60 are adjusted for inflation when calculating your lifetime income contribution amount. Earnings after the age of 60 are not. So if you keep working into your mid to late 60's and have well over 35 years of contribution the income you contribute in those later years even if at a higher salary may be the ones that are thrown away and thus you will not increase your benefit one dollar by working more. My father is 75 and a semi-retired farmer but he still farms the land he owns. He makes enough from that to still make a sizeable contribution to social security on the order of 3-4000 per year. A decade ago that used to marginally increase his payout because he would be throwing away a smaller year and keeping a larger year. He of course was not happy with the arrangement because he contributed $4000 and got his payment increased like $4 per month. Not exactly a good deal. Now the earlier years have been adjusted for inflation and thus larger than his new contributions thus he now contributes about $4000 and gets no increase in his payments. He is even less happy with this arrangement. :)
Posted by: Apex | October 19, 2011 at 11:25 AM
LOL, I see some comment that I thought I had erased made it on the end of my post. Its a little misplaced and somewhat redundant in the flow but it does show an example of someone who had contributed so many years to social security that he is paying in large annual contributions and getting zero benefit for it.
Posted by: Apex | October 19, 2011 at 11:27 AM
On point #1, I just had a good example of that. My daughter's friend has been out of work for over a year. This month she went to a headhunter and he said that her problem, with all her experience and education, was that she was not asking for enough money. The headhunter said that if you don't recognize your worth, a company willl think twice about hiring you.
And from fighting to get a few interviews, she went to 8 in one week - 3 being companies that have been doing multiple interviews with prospective employees.
Posted by: Georgia | October 20, 2011 at 09:40 AM