One Reason You May Want to Wait to Retire

As many readers know, I have entertained thoughts of early retirement now and then. I still have almost 20 years before I hit the "normal" retirement age and my savings is well above where it needs to be, so the chances of me stopping work early is a real possibility.

But if I do, I could be hurting the amount of Social Security I receive when it comes to that time. Here's what MSN Money says about retiring early and the impact on SS benefits:

Don't retire too early. Your Social Security payment is based on the average of your best 35 years of work, adjusted for inflation, so if you retire too soon some of those 35 years will be computed as zeros. Let's say, for example, that you started work after college, at age 22. That means you won't have 35 years of earnings on the books until you're 57, and those zeros can put a big drag on your average income.

So if you earned an annual average of $60,000 over your best 35 years, your benefit will be computed on that $60,000. If you worked only 30 years and then went to lie on a beach somewhere, your Social Security benefit will be computed as the average of those 30 years at $60,000 plus another five years at a whopping $0. That brings your best-35-years' average down to just over $51,000, which, depending on the age you retire, could cut significantly into your benefit.

A few thoughts on this:

• I'll start by saying that I'm not counting on Social Security to fund any of my retirement. That said, I want to get the maximum benefit I can if it's available for me. (I certainly paid enough into it -- I want to get as much out as possible.)


• That's a 15% hit if you "only" work 30 years. If you work 25 years, you get 10 years’ worth of $0 in earnings added in and thus lose 29% in earnings (your average ends up at $42,857 in the example above.) That's a pretty big hit.


• This is just another good argument for working at least part-time when you "retire." Add an extra point for early semi-retirement.


• For those who can work longer, the above suggests that doing so can have a big impact on what you might earn in Social Security benefits. Because the dollars you receive are calculated on your BEST 35 years, if you replace those early years of your career (when you presumably didn't earn as much) with some peak-earning years, the results could be massively different.


• At some point I'm sure benefits are capped anyway. I assume that because payments are capped based on income, so it makes sense that benefits would be too.


• Does it really make that much difference? Perhaps the loss between averaging $60k a year and averaging $51k is $3 per month. Anyone know for sure?


• Is it really worth what you're giving up? At some point, if you have enough saved up otherwise, why even worry about Social Security? Just retire and live it up!

Anyone have any comments on the above? Anyone had to deal with/consider this issue as you planned for early retirement?

Comments

[Greg]

Let's assume that Alice works 35 years and was paid $50k each of those years.

Let's assume that Bob works 45 years and was also paid $50k each of those years.

Finally, let's assume that Charlie works 25 years and was also paid $50k each of those years.

Based on my rudimentary understanding: At full retirement age, both Alice and Bob get paid the same amount in SS benefits. However, Alice paid almost 29% more in SS taxes due to 10 extra years of work. Meanwhile Charlie gets about 29% less in SS benefits than either Alice or Bob, but Charlie paid almost 29% less in SS taxes compared to Bob and more than 44% less in SS taxes than Alice.

It seems that Alice (45 yrs) losses out while Bob (35 yrs) and Charlie (25 yrs) are on equal footing. The reduction of your SS benefits seems like a lame reason to not retire early.

[Greg]

(correction)

Let's assume that Allen works 45 years and was paid $50k each of those years.

Let's assume that Bob works 35 years and was also paid $50k each of those years.

Finally, let's assume that Charlie works 25 years and was also paid $50k each of those years.

Based on my rudimentary understanding: At full retirement age, both Allen and Bob get paid the same amount in SS benefits. However, Allen paid almost 29% more in SS taxes due to 10 extra years of work.

Meanwhile Charlie gets about 29% less in SS benefits than either Alice or Bob. And Charlie paid almost 29% less in SS taxes compared to Bob and more than 44% less in SS taxes than Allen.

It seems that Allen (45 yrs) losses out while Bob (35 yrs) and Charlie (25 yrs) are on equal footing. The reduction of your SS benefits seems like a lame reason to not retire early.

[Apex]

Here are some reasons why this doesn't matter that much.

(1)
"if you replace those early years of your career (when you presumably didn't earn as much) with some peak-earning years, the results could be massively different."

Maybe, but probably not as much as you think. Every year you work prior to age 62 your earnings are adjusted for inflation. After age 62 they stop adjusting them even if you keep working so that kind of stinks. So for instance if you earned 30K 20 years ago and earn 60K now and inflation was 100% over the past 20 years then the 30K will be counted as 60K when it comes to your SS formula so both years would count exactly the same in that instance. Probably you are growing wages a little faster than inflation but the early years will still be a lot closer to the later years after they are adjusted.

(2)
For high wage earners this reason is the most important. The SS formula is heavily progressively weight to give greater benefits to lower income earners so high earners get much smaller benefits from the top half of their wages. The good thing is this is not done on a year by year basis but on a full lifetime earnings basis based on your top 35 years of earnings as stated above. The formula uses something called Average Indexed Monthly Earnings (AIME) to calculate your Primary Insurance Amount (PIA). The formula has three separate percentages based on what are called 2 different bend points.

http://www.ssa.gov/oact/cola/Benefits.html

These bend points adjust year by year with inflation but they are set so as to ensure that the lowest income earners receive the largest percentage benefit and the highest income earners receive the smallest percentage benefit.

The percentages for this formula are fixed by law and the bend points adjust year by year with inflation but their ratios to each other are also fixed.

http://www.ssa.gov/oact/cola/piaformula.html

Here are the actual numbers for the formula for 2012

to determine your PIA (which would be your monthly payment) you would do the following:

take
90% of the first $767 of your AIME add that to
32% of the value of your AIME between $767 and $4624 add that to
15% of the value of your AIME over $4624

So what would this look like. Lets say you had paid in on average 80K of FICA over 25 years of working (after adjusting for inflation your early years could easily equal that amount even though the FICA cap was lower than that).

That would give you total earnings of 80K*25 = 2 million. Divide that by 35 years and 12 months per year and you get an AIME of $4762.

Now if you look at the formula above you can see this already puts you in the lowest percent of the formula even though you are 30K below peak FICA earnings and 10 years short of the maximum number of earnings years. If you pay in on the cap you can get here in less than 20 years.

Once you are in the 15% of the formula you are paying in the same percentage on your FICA and you are getting 1/6 the benefit of the first 767 dollars per month that you pay on and less than half the benefit that you get on the dollars below $4624.

SS is already a poor return on your tax dollar but this last portion of the formula where you only get 15% of the benefit is a terrible return. You would be far better served to never pay a dime of that money because you won't get 50 cents on the dollar back on that money.

Just as an example lets look at what the payouts would actually look at in this example versus someone who continued to work at the 80K level for the next 10 years to get a full 35 years of work.

This AIME of $4762 would net you a monthly SS payment at full retirement (age 67) of $1945.24 (90% * $767 + 32% * $3857 + 15% * $138)

If you worked and made 80K for another 10 years your AIME would be $6,667. Wow that's a lot bigger AIME right. You paid a lot more FICA taxes to get that AIME way up there. So what is your monthly payment on that AIME. It's $2230.99. $285 more per month on 80K of extra earnings tax of 12.4% between you and your employer for SS Tax. That was a total extra tax of almost 100K to get you an extra $285 per month starting at age 67. It would take 30 years to get that back assuming no interest.

(3)
If you work more than 35 years then even if those years replace lower earning years your bang for the buck is even less. My dad is 76 years old and still farms. He pays like 6-8K a year in FICA taxes. It replaces some pretty low earning years. It raises his payment about 6 bucks a month. A few years he made less money and only paid about 4-5K in FICA taxes. That did not raise his payment at all.

Once you have put in 20-25 years of high earning years into the social security system you have already earned about 75-80% of the maximum benefit you can get from the system. If you still need to work then obviously that's the thing to do. But continuing to work simply to get a higher social security payment is probably not the right reason to do because you have already earned most of your payment by that point and the increases will be modest at best from there.

[FMF]

Apex --

Based on your comment, I'm retiring at 50 and not thinking a thing about it! :)

[Apex]

@Greg,

Close, The formula is complicated and not straight line and early years are adjusted for inflation as you can see if you follow my extremely long post. The gist of what you are saying is correct but the numbers work out a little bit differently. You used more average income levels so the high end reductions that I discussed won't really come into play in your example. For high income earners though (those in the 75K+ area) the final 10 years really get chopped considerably so that they provide you very little benefit. If in your example you had used 100K instead of 50K you would find that all three would get very similar checks.

[Jim]

Greg,

Yes in those scenarios Allen would lose out. However such a theoretical situation like Allen doesn't really happen except in extremely rare cases.

Most people don't work 45 years straight. But if you do then your wages aren't flat. Allen would have likely started at lower wages when he was younger and gotten higher raises after 10-20 years experience. You may also have some gaps in income where you are temporarily unemployed or between jobs. Its more likely that Allen would have wages that gradually increased over time and then they'd take his 35 best years. By comparison someone who worked only 35 years would also have wages that increased over time and they'd include all their best and worst income years.

[Apex]

@FMF,

That's funny because based on my rental business I am thinking along those exact lines. Since rental income is unearned there is no social security taxes on it. But I am already close to or crossing the second bend point so I have already earned most of my social security check. That is something I have factored into my future plans.

[FMF]

Apex (and others) --

Not to let the cat out of the bag prematurely, but I'm tracking with you 100%. I am close to buying my first rental place with more to follow. Stay tuned for details...

[Apex]

@FMF

Nice! Welcome to the club, everyone is doing it these days. :) It will be interesting to hear the details.

[Lance @ Money Life and More]

Seems like I thought that social security doesn't add as much benefit as many people think. I'd do the calculations myself but it doesn't sound like you'll miss out too much. I'm sure there is a calculator somewhere.

[Young Limey]

Thank you for writing this blog because if you not sure what to do, it's certain that the vast majority of readers are as well. It's just a shame that the financial 'news' information, like that of the MSN article you reference, don't tell a complete story.

FMF, your blog, and comments like those from Apex are so helpful. Apex, I will definitely be referencing your comment countless times in the future!

[Old Limey]

I paid into Social Security for 34 years, retired at 58, and started collecting benefits at age 62. My monthly benefit is $1,436.80 before medicare deductions, and I have been on SS for 16 years, but getting my pension for 20 years.

One way you can maximize your total benefit is by living a long time, so my advice is keep fit, exercise, minimize stress, watch your weight, eat a healthy diet of fruits, grains, and vegetables while cutting back as much as possible on meat and dairy products, and especially the poison known as Sugar that is in so many products, especially soft drinks.

The other thing is that regardless of money there will come a time when you decide that you really want to retire and do a lot of things that just can't wait until you're too old to do them. Regardless of your age when you retire the future will always be a big unknown and if you keep putting off retirement you're jeopardizing an important phase of your life that in my case has turned out to be a wonderful time, free of responsibilities and stress, and all yours to enjoy. I also, never in my wildest expectations expected to make far more money from my investments in 20 years of retirement than I made from working for 36 years (2 in Canada and 34 in the USA).

[S. B.]

Well, I see Apex already provided a comprehensive and correct summary of why the input/output relationship is not linear, so that saved me a lot of typing! I looked at this issue about 5 years ago when I was trying to understand how much social security I would lose by retiring early. Given my particular situation, it's much less than I thought.

[Jeffinwesternwa]

If social security is nothing but EXTRA $$, then you don't have enough saved to retire (early), I did at 47 and have 33 years of some earnings on my record for SS wages/self emplyment income, .. I "expect" about $1250~ (todays dolllars) at age 62 and closer to $2K+ if I delay to age 70. Do I need it no, but, it'll be extra FUN..

[Mike Hunt]

Since I moved overseas in 2006 I have not contributed anything to social security. It also means I only have 10 years of real solid contributions.

Not sure how to get around this and after reading Apex's comment I think I am better off anyway (have always suspected this before).

-Mike

[Holly]

I am fearful that posts like these are going to keep many people working well into their golden years, even though they could have and possibly should have retired by age 60 or sooner. Time is precious, use it wisely.

There already are plenty of younger workers unable to advance in their careers (or even able to get into their field of choice) due to the older workers staying put for too long (particularly in lucrative, non-physical employment ).

[Mark]

@Holly: When you suggest that older workers are blocking younger workers, you sound like the French government enforcing a 35-hour workweek to "give everyone a job". The net effect was slower economic growth which costs everybody.

What specific fields are overcrowded with older workers? What data do you have to support the contention that this holds younger workers back?

Perhaps people would be better off withdrawing from the workforce, but are you really saying it is the ethical thing to do in order to give younger people the opportunity?

[Jim]

Mark, as a general nation wide trend thee labor force participation rate among older workers (55+) has gone up about 8-10% in the past 10 years from ~30% to ~40% and at the same time it has gone down for young workers age 16-24 from 62% to 54%.

See chart 2 :
http://www.bls.gov/opub/ils/summary_10_04/older_workers.htm

I'm not saying that old people are stealing young peoples jobs but older people as a group are working more and younger people are not working as much.

[Jim]

Also for people age 64-69 the labor force participation went from 21% in 1995 to 32% in 2012.
That rate has been on a general upward trend since the late 90's and isn't a direct reflection of the recent recession.

[Mark]

@Jim: I don't dispute those statistics, but correlation is not causation.

Perhaps these labor force participation rates are a function of health and longevity, which drive need, ability and desire to work.

My question to Holly was whether there is any data to support her contention concerning "younger workers unable to advance in their careers due to the older workers staying put for too long".

[Jim]

Yeah,well I don't know what the causes are specifically. As I said I'm not trying to argue that old people are stealing jobs from the young. Was just providing the data about labor force trends. I don't know the specific causes, but honestly I'd assume more old people are working lately since they failed to save for retirement.

Health and longevity hasn't changed too much in the past 10 years and I wouldn't assume that would drive 50% increase of people age 65-69 who are working.

[Terry]

While that's a 15% hit to your credited earnings, it's not quite a 15% hit to your expected benefit. The benefit structure is progressive with three 'brackets'.

The lowest earners up to a threshold get a very high proportion (nearly 100%) of their earnings credited to their benefit by the formula, middle earners get about 50% on earnings above the aforementioned threshold, and the highest earners get very little (nearly 0%) on earnings above the middle threshold.

So I would expect a 15% hit in credited earnings to result in perhaps a 10% hit in monthly benefits, and certainly not 15%.

But of course you do want to avoid any years of zero unless you are safely in the stratosphere, with earnings so high you would be foregoing an insignificant amount and you have better things to do with your time.

[Terry]

Um, kindly disregard above comment. I jumped in without reading responses and now see that Apex nailed it.