Our clients often come to our retirement investment advisors with questions about Social Security. When is the best age to start withdrawals? Are there benefits to waiting longer to claim payments?
We understand why so many have questions about the program. After all, in 2014 alone, more than 59 million Americans will receive an estimated $863 billion in Social Security benefits and, of these, 74 percent of unmarried recipients and 52 percent of married couples depend on Social Security for at least half of their income, according to the Social Security Administration. Given that so many Americans depend so heavily on this program, it's important to understand how it works -- and how the age you decide to start taking benefits will affect the amount you receive.
Investment Guidance: How are Social Security Benefit Amounts Determined?
The amount of Social Security benefits you'll receive each month is based on two factors:
- Your work history and lifetime earnings
- The age at which you start claiming benefits
Your lifetime earnings are calculated based on your average monthly earnings during the 35 years of your life that you earned the most. This number is indexed, or adjusted to reflect changes in average wages during your working years, as well. The Social Security Administration uses a formula to calculate your primary insurance amount or PIA; your PIA is based on the amount you would receive if you began claiming at the so-called "full retirement age."
Ask a Retirement Plan Advisor: What is Full Retirement Age?
The Social Security Administration defines "full retirement age" -- or the age at which you're eligible to claim and receive full benefits -- as age 65 and older, depending on the year you were born. Specifically:
- If you were born before 1955, your full retirement age is 66
- If you were born from 1955 to 1959, you can claim full benefits when you turn 66, plus two to 10 more months
- If you were born from 1960 on, you can claim full benefits once you turn 67
You start claiming benefits as soon as you turn 62 -- but you won't receive full benefits. In fact, for every month left until you reach full retirement age, the Social Security Administration will deduct a percentage from your payment.
Imagine, for instance, that your full retirement age benefit was $1,300 per month. If you claimed that benefit four years early, you might lose a quarter of your benefits, reducing your monthly payment to $975. Over time, these deductions add up to a significant amount.
Financial Strategies: Delaying Retirement Leads to Larger SS Benefits
Now let's flip this scenario on its head. Imagine that you wait to claim your benefits until after you reach full retirement age. You will gain up to an extra 8 percent per year until you reach age 70; that $1,300 per month payment you began with at full retirement age would grow into a $1,716 per month payment if you waited to claim benefits until age 70.
And just as the deductions for taking Social Security early add up over time, so do the benefits of waiting to claim. Imagine that you claimed your $1,716 per month benefit at age 70. If you lived to be 87, you'd claim $350,000. Now compare that to starting benefits at age 66; you'd end up with $327,000 at 87. However, if you claim benefits at age 62, your total at age 87 would be only $290,000.
The bottom line is this: Delaying Social Security benefits for as long as you can results in more income for you over the long run -- and vice versa. Either way, Social Security is designed to replace 40 percent of your income, so a focus on personal retirement savings is still essential.