So far we've talked about the parts of retirement saving most under your control: the 401(k) and IRA. Now let's turn our attention to what, for most people, will be a major part of their retirement: Social Security.
Important: for the purposes of this discussion, I'll be talking about Social Security as it is currently configured. Obviously the republicans will be doing their best to dismantle it (as we've already seen this month with their attacks on Social Security Disability) but since I'm not interested in trying to predict the future, we'll assume the program stays more or less the same. Also, all numbers are current as of 2014; since this is now 2015, assume they're probably slightly out of date.
This diary discusses only the retirement part of Social Security, not the disability coverage.
Coincidentally, the day I decided to write about Social Security, I got my Social Security statement in the mail. As you may recall, getting these used to be a regular thing, but Congress largely got rid of them in 2011 to save money. As of last year, most workers will get one every five years; since I'm turning 35 this year, it's my turn! Once you hit 60, you start getting annual statements again. An exception: if you don't want your Social Security information being sent through the mail, you can sign up for a my Social Security account and see your statements online.
Your Social Security Statement
The Social Security statement tells you both how close you are to qualifying for benefits and how much you can expect to receive. Before getting into the numbers, though, it starts off with a warning:
Social Security benefits are not intended to be your only source of income when you retire. On average, Social Security will replace about 40 percent of your annual preretirement earnings. You will need other savings, investments, pensions or retirement accounts to make sure you have enough money to live comfortably when you retire.
So now that that's out of the way, let's take a look inside.
The first thing you might notice, depending on how many credits you have, is that your statement might not actually tell you how much you'll get when you retire. However, you can figure it out yourself - see the calculators below. Your benefit is calculated based on the highest 35 years of Social Security earnings, adjusted to account for changes in average wages over time. Once you've earned over 40 credits (as described below), Social Security will provide an estimate of what your benefit will be, assuming that your future (adjusted) earnings are the same as your current earnings; this estimate should become more accurate as you get closer to retirement.
Calculating Your Benefit
Once you've calculated your adjusted average monthly earnings (see the instructions here if you want to do so manually, or use this calculator to calculate your benefit automatically), you do the following:
1) Multiply the first $816 by 90%
2) Multiply the amount over $816 and less than or equal to $4,917 by 32%
3) Multiply any remaining amount by 15%
4) Add up the numbers from the previous 3 steps. This is your estimated benefit at full retirement age.
As you can see, Social Security benefits are quite progressive; someone making under $10k/year will have almost all of their wages replaced, while someone making over $59k will only replace 15% of earnings between $59k and the cap ($118,500 for 2015).
Of course, if you pay into Social Security for fewer than 35 years, those 0s will drag down your average. Additionally, in order to qualify at all, you must have at least 40 credits of work; however, since each $1,200 of wages is a credit (to a maximum of 4 credits per year) almost everyone who collects Social Security wages for a few decades will qualify. Note that some government workers (including me, when I was teaching) pay into a pension plan instead of Social Security. Workers receiving both a pension for a job where they did not pay into Social Security, and Social Security benefits, may additionally be affected by the Windfall Elimination Provision, which reduces SS benefits based on the amount of the pension.
Once you earn 40 credits, you are considered fully insured and will qualify for benefits once you reach retirement age, even if you stop working.
Adjusting for Retirement Age
Originally, full retirement age for Social Security was 65; it is higher for anyone born after 1938 (which I'm guessing is pretty much everyone reading this). The age increases gradually until it hits 67 for people born after 1959; you can see your full retirement age here.
Aside: raising the retirement age again seems to be one of the most likely actions Congress might take to shore up the SS trust fund.
The benefit is based on your estimated life expectancy, so while you can start taking benefits early, this will reduce the monthly payment by an amount that should, on average, result in you taking the same total benefits as you would if you had started at full retirement age.
Let's assume that you were born in 1960 or later. (Well, I'll assume that; I hope you actually know). Your full retirement age is 67. If you start taking benefits at age 62, you will get only 70% of the expected amount, for as long as you collect benefits. Start at age 65, and you get 86.7%. If you are collecting benefits based on spousal earnings (details on this below) then the benefit is reduced in the same way: you get 50% of whatever the reduced benefit would be.
This works the other way as well. For each month after full retirement age that you delay taking benefits, up to age 70, your monthly benefit will increase; the rate is 2/3 of a percent per month (8% per year) for someone born in or after 1943, which means you can increase your benefit by 24% if you wait until age 70 to retire. As someone put it in an earlier thread: delaying SS benefits for a year is like buying a good annuity. You'll get a guaranteed 8% return every year for the rest of your life.
Note: even if you're delaying retirement, you still need to sign up for Medicare when you turn 65. For each year you delay, your premium increases by 10%.
When to Begin Taking Benefits
For many people, when to start benefits isn't a choice; they're unable to work past 62 (either for health reasons or due to inability to find work) and so have no choice but to begin taking SS. But if you have the choice, when should you start benefits?
Many people will say that you should never take early SS, and there's a strong case to be made for that argument. Recall from above that the difference between taking benefits starting at age 62 and starting at age 70 is going from 70% to 124% of your earned benefit - waiting for eight years increases your monthly benefit by an astonishing 77%! And of course, due to the cost of living increase being factored off of this baseline, the actual dollar difference will only grow over time.
On the other hand, for those eight years (and a few years thereafter) taking the early benefit will result in collecting more money. How far after? Collecting 70% for 8 years means you'll have collected 5.6 years worth of your full SS benefit. After that, the late benefit catches up at a rate of 0.54 years (of the regular benefit) per year, which means that the person who delays will have collected more money starting sometime after his 80th birthday (and will continue to gain after that). Starting benefits exactly at full retirement age, of course, will be in between; total payments will be lower than taking benefits at age 62 until age 78.7, but higher than retiring at 70 until age 82.5,
So which option will produce more money in the long run will depend on how long you actually live to collect benefits. (This analysis is a bit simplified, of course; it neglects both the time value of money and family benefits, which are discussed below). In theory, the benefit should be calculated such that, given the average age of death, the total benefit will be approximately the same no matter when you begin taking benefits; in practice, a number of factors mean there is no one answer that applies to everyone.
Some considerations that may apply:
Longevity
The average 65-year-old man can expect to live until age 83, and the average 65-year-old woman until after 85. These numbers vary, of course, according the a number of factors; for example, richer people tend to live longer. However, these are averages; the government estimates that one in three 65-year-olds will live to age 90 and more than 1 in 7 will live to age 95 - and these numbers have been increasing over time. If Social Security does not increase in line with inflation (for example, with chained CPI) then the benefit will shrink relative to expenses as time goes on, making it more important for people who live a long time to have a higher base benefit.
Relative Growth
Someone who retires early may have a choice between taking SS benefits or withdrawing from a 401(k). If the market is down, it may make more sense to take early SS benefits, as the market recovery may be more than the money lost from taking benefits early. Additionally, once the market recovers, you can suspend your SS benefits and allow them to grow again while taking money out of your 401(k) instead.
While you don't have to start taking SS benefits as soon as you retire (assuming you have another source of income) you also don't have to retire to start taking SS benefits. If you are not ready or able to retire but need additional income, you can take SS while working. If you are under full retirement age, your benefit will be reduced by $1 for every $2 over $15,720 you earn in a year (much more generous rules apply for the year you reach full retirement). Once you reach full retirement age, earnings no longer reduce benefits. Once you reach full retirement age, Social Security will recalculate your benefit (possibly increasing it) to account for months when you had a reduced benefit. If you continue to work, Social Security will also review your record each year to see if your benefits should be increased based on your new earnings.
Quality of Life Considerations
As much as we hate to admit it, getting older means not being able to do the same things we used to do. The older we get, the more our bodies tend to break down. If taking SS benefits earlier allow you to accomplish something meaningful (for example, traveling to a country you've always wanted to visit) that health concerns might prevent at a later date, this may trump financial considerations.
Family Benefits
If you don't work but your spouse does, you may still qualify for SS benefits. Even if you qualify for benefits on your own, you may still get more benefits from your spouse's earnings. The rule is that (at full retirement age) you get the greater of your earned benefit, or 1/2 of your spouse's earned benefit.
It is also possible for your children to receive benefits; generally this only happens if they are under the age of 18. If you are caring for your spouse's children under the age of 16 and they are receiving social security benefits from him/her, then there is no age restriction for you to receive spousal benefits.
Your Social Security statement shows the amount of family benefits available; this is listed as a benefit for your child, for your spouse caring for your child, for your spouse at full retirement age, and a family maximum.
If you are divorced after being married for at least 10 years, are unmarried, and are 62 or older, you can qualify for spousal benefits (regardless of whether your ex has remarried). You can even take the spousal benefit while delaying your own and later switch to your (increased) benefit (still-married spouses can do this as well).
Here is a short article from Forbes discussing strategies that couples can use to maximize their SS benefits.
Summary
So, to summarize:
- Social Security replaces some of your wages during your retirement years, but is not meant to cover all of your needs
- The total benefit will be a percentage of the weighted average of your highest 35 years of earnings
- For most people reading this, full retirement age is 67. You can begin taking benefits as early as age 62, and deferring benefits will cause them to grow until you reach age 70
- When to take benefits depends on your personal circumstances; there is no one answer that works for everyone
- Your family may be entitled to collect benefits based on your work
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Previous diaries in the series:
Part I: the 401(k)
Part II: Running the Numbers
Part III: Lower Risk, Higher Return