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How Early Retirement Impacts Social Security Benefits

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Early Retirement impact Social Security BenefitI originally wrote this post in 2012 to figure out how early retirement impacts Social Security benefits. It’s been 4 years so I thought I’d check my Social Security statement and update the post with some current numbers. Also, it was National Social Security week earlier this month, April 4-13th. The Social Security office wants you to create a “my Social Security” account to make it easier to check your statement. You can verify your earnings and see your benefit estimate online. The timing is not good, though. That week was right before the tax return filing deadline and everyone was busy trying to wrap up their taxes. I guess if you’re done, then it would have been a good time to check your tax information with your Social Security statement. I don’t know about other people, but I mailed in my tax returns on the last day. Anyway, now that I have a little breathing room, I can go over my statement. First, let’s review how the Social Security benefit is calculated and then see how early retirement impact my benefit.

Social Security recap

In the United States, Social Security is the Old-age, Survivors, and Disability Insurance (OASDI) federal program. Social Security is funded through payroll taxes and is meant to be a safety net for all qualified workers. We’ll focus on the Old-age or retirement part of the program today. Not everyone is qualified for Social Security retirement benefits. Here are the important things to know about Social Security.

  1. You need 40 credits to be eligible for the Social Security retirement benefit. You can earn up to 4 credits each year that you have earned income and paid into the program.
  2. The benefit (Primary Insurance Amount or PIA) is calculated from your average indexed monthly earnings (AIME.) This takes your highest 35 earning years and averages them out to a monthly earning. Once you have the AIME, then the benefit is calculated with the following formula.
  • A) 90 percent of the first $856 of his/her average indexed monthly earnings, plus
  • B) 32 percent of his/her average indexed monthly earnings over $856 and through $5,157, plus
  • C) 15 percent of his/her average indexed monthly earnings over $5,157.

The graph below is sometimes called the “Benefit Formula Bend Points.” This graph shows that the more you earn, the more benefit you will receive in retirement.

Social Security Retirement benefit formula 2016

We can see that the less money you made over your working life, the more helpful Social Security will be in retirement. If your AIME is about $1,000, then Social Security benefit would replace almost 90% of your income. As the AIME increases, the benefit covers less percentage of your income. So if your AIME is about $10,000, then you’d receive about $2,800 or 28% of your average income. I think this is about right because lower income workers need a lot more help than highly compensated workers. High income earners can save more in their retirement accounts and pay for their own retirement.

Early Retirement Impacts Social Security Benefits

Social Security is a bit uncertain for my generation because the program will start to run out of money right when we hit our 60s. If Congress doesn’t reform the program by 2037 then it will only have enough money to pay out about 75% of the full benefit amount. Any reform is going to be tough because Congress can’t come to a consensus and keeps kicking the can down the road. If they ever get their act together, I suspect the program will increase the payroll tax cap* and increase the retirement age for young workers. We’ll ignore that for now and hope for the best.

*For 2016, you pay social security tax up to $118,500 of your earnings.

If you paid close attention to the recap above, you would notice that early retirement will decrease your Social Security benefit. Retiring early means you will miss out on your peak earning years and this will reduce your AIME which is the average of your 35 highest earning years. I quit my engineering career at 39 and I still don’t have 35 years of earnings yet. Luckily, I had some income over these last few years, but who knows how long that will continue. Here is the chart of my income that was taxed for Social Security.

earning

I will use the online Social Security Benefit estimator to look at a few scenarios.

Scenario Benefit estimate at 67
Fully retire now, no more earned income $1,974
Continue working part-time, earning about $36,000 per year $2,253
Go back to work full-time and earn $100,000 per year $2,699

 

There isn’t a big difference between the three scenarios. It looks like I already paid into the program enough to receive a good portion of the benefit. I’m near the 2nd “bend point” and from now on, the increase in benefit I receive from paying into the program will be minimal.

After 4 years of part-time work

Things are actually looking pretty good. When I quit my job in 2012, I thought I’d make about $25,000 per year and I’ve been doing a bit better than that. For now, it looks like my Social Security benefit should be around $2,000 per month. That’s pretty darn good. If we can keep our expense at the same level, then this will cover about 40% of our monthly expense. Mrs. RB40 should also receive similar level of benefits, so our combined benefits should cover the majority of our retirement expenses. Our retirement portfolio would easily cover the rest.

In conclusion, we could both work full-time for 25 more years and Social Security retirement benefit will cover 100% of our living expense. By retiring early, our benefit will be reduced, but we would make up for the shortfall with our investments. Hopefully, Congress will reform the program at some point and keep it going. I’m pretty sure we will get some benefit, but I’m not counting on it too much. If all goes well, our retirement fund alone should be enough to pay our cost of living. We’ll use the Social Security checks for fun money or to help improve the world.

Have you checked your Social Security statement lately? Are you counting on this benefit to fund your retirement?

Image by CJ Johnson

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{ 67 comments… add one }

  • William @ Drop Dead Money August 8, 2012, 3:54 am

    Not only is the amount getting reduced, the age at which it starts could change, too. Your attitude is probably the healthiest one: don’t count on it.

    Also keep in mind that the value of your investments/assets is affected by the economic cycle. Cycles in the recent past have all been 7-10 years in duration, bottom to bottom. You can get a significant jump by (once a decade) selling and buying. Depending on the severity of the downturn, you can add a 20-30% jump in value every cycle. Most importantly, you won’t get caught (like many did recently) where you have to liquidate at a down time.

    Wish I knew all this when I was you age… 🙂

    • retirebyforty August 8, 2012, 7:38 am

      I’m terrible at the whole economic cycle thing. I’ve been just adding into the investment regularly to take advantage of dollar cost averaging. However, now that I’ll invest less, I’ll have to be smarter about the economic cycle.

  • I personally don’t count on social security being around in its current form either. I don’t have plans to quit the corporate grind anytime soon but it is good to know I will need to forecast this to see how it will affect my potential retirement fun money!

    • retirebyforty August 8, 2012, 7:37 am

      I guess the younger you are the less you can count on. I’ll probably get less benefit and perhaps the full retirement age will rise a bit. We’ll see what happens when Washington deal with this.

      • Mr. Tako @ Mr. Tako Escapes April 25, 2016, 8:22 am

        I’m in the same boat. For my own calculations, I did not include SS. I assumed $0. Everything else is going to come from small businesses and investments.

        Anything we do end up receiving will be gravy on top!

    • Nurse Frugal August 8, 2012, 9:59 am

      I don’t plan on it being there either!! I expect to retire off of my own money! Social security was meant to be a supplement and people are now expecting it to be their entire means of retiring! Such a scary and unstable idea!!!

      • retirebyforty August 8, 2012, 4:13 pm

        That’s great to hear. Most readers agree with you.
        It’s too bad so many Americans have so little retirement saving. It’s a tough situation.

  • krantcents August 8, 2012, 7:00 am

    The glass is half full too. You didn’t pay much into it, but look at what you will receive. I have been out of the Social Security system for years because the school district pension scheme and self employment. The penalty is minor compared to what you can elsewhere. When I retire (again) I will be penalized because I receive a pension.

    • retirebyforty August 8, 2012, 7:35 am

      Can you get spousal benefit? My mother in law just retired from teaching and she is in the same situation as you. I haven’t look into how pension changes the calculation. Thanks for the info. I’ll look into that.

  • Mr. Everyday Dollar August 8, 2012, 7:12 am

    A really great exercise, thanks for sharing. I figure my taxable investment account will cover me from early retirement to “real” retirement at 60-something and perhaps beyond. My 401k will be an added bonus at “real” retirement and social security will be fun money, if the program is still around at that time.

    • retirebyforty August 8, 2012, 7:40 am

      No problem. That’s similar to what I’m doing. I’m doing some freelancing to help the taxable account. I don’t want to draw down too fast.

  • Financial Samurai August 8, 2012, 7:28 am

    Good stuff Joe! Can you clarify when you say you have 20 years of earnings? Does that mean your part-time jobs at under 20 years old counted?

    $1,600 is still nice bonus money!

    • retirebyforty August 8, 2012, 7:33 am

      Yes, any year that you had earning count toward the 35 years. I had a few years with around $3,000 earning.

      • Sam August 8, 2012, 7:22 pm

        Gotcha. So I guess I have 15 years then given my work in HS. I should just check my SD statement.

  • Kurt @ Money Counselor August 8, 2012, 7:39 am

    Very interesting. From what you’ve written, the ‘extra’ SS benefit you would have received had you continued with your corporate job until age 67 is a pittance compared to the toll doing so would have taken on you. One can’t buy good health. Not to be too grim, but Mrs. RB40 may well have been collecting SS survivor benefits 20 years from now if you hadn’t elected to make a change in your life!

    • retirebyforty August 8, 2012, 4:07 pm

      That’s the biggest reason why I left the old job. My health was getting worse and worse and that’s not the right way to live. More money isn’t worth that.

    • Steve August 8, 2012, 5:59 pm

      I wouldn’t call it a pittance, but working full time for 20 years would only raise your benefit by 50%. Hardly seems worth the effort – if you can live on the lower amount.

      On the other hand, the employer would also give you money directly, so maybe it’s not all that bad to have a day job.

      • retirebyforty August 9, 2012, 12:08 am

        A steady paycheck is definitely nice. 🙂

  • Jeff @ Sustainable Life Blog August 8, 2012, 8:13 am

    Interesting analysis joe – glad to know how this affects a persons social security. Do you still need to count rental properties as “income” and pay ss tax on them?

    • retirebyforty August 8, 2012, 4:08 pm

      Rental, interest, and dividend are not earned income and you won’t need to pay ss tax on them. Welcome back from your honeymoon. 🙂

  • SavvyFinancialLatina August 8, 2012, 9:34 am

    At 22 and with 43 years to go till “retirement” (65 years right?), I have a long way to go and I don’t think social security will be an option by that point. I’m not even counting on it. The money that goes out of my paycheck, unfortunately, I consider lost money, the cost of living in the America. Great article though! It definitely informed me about SS benefits. So now when older people talk about their SS benefits, I’ll know how it’s calculated.

    • retirebyforty August 8, 2012, 4:11 pm

      I’m sure social security will be reformed at some point. Our government might surprise you. 🙂

      • SavvyFinancialLatina August 8, 2012, 8:39 pm

        Well, if it is, it will be a nice surprise and I will consider it extra money. I’m not planning for it to be part of my retirement portfolio though. Plus by the time I “retire”, the government might have pushed the retirement age to 75 because we are living longer due to medical advances! LOL Although I wouldn’t want to live past 80.

      • Will April 26, 2016, 5:39 am

        Of course SS will be there in the future. Politicians want power and know they will be voted out of office if they reduce benefits. They also know we own guns and are scared to death of people rioting in the streets. SS will never pay all you bills, but it will be there.

    • jim April 26, 2016, 11:08 am

      “(65 years right?)”

      Full retirement age for anyone born 1960 or after is 67 years.

  • 20's Finances August 8, 2012, 10:01 am

    This is an excellent illustration of retiring early – and I say that knowing some people may think I am a spammer. 😉 Between the two of you, social security and your rental income would cover almost all of your expenses without calculating inflation – and that’s not even touching your nest egg. That must feel pretty good!

    • retirebyforty August 8, 2012, 4:14 pm

      That does feel pretty good. 🙂 Any extra money we get can go toward our travel fund.
      It’s still a long way until full retirement age so many things can happen, but I’m sure we’ll be all right.

  • Thanks for the info. How in the world do they come up with those formulas? Like you, we will just use SS as a bonus and not count on it. My in-laws made some bad financial moves and are living solely on SS right now. It is a very meager existence. Best advice is to just be self sufficient.

    • retirebyforty August 8, 2012, 4:16 pm

      It’s good that it’s not linear. Well off earners need less help than low income earners.
      My in-laws have pensions so they are doing pretty well. 🙂

  • Darwin's Money August 8, 2012, 10:13 am

    Really cool analysis, thanks for putting this together. It gives me some perspective and we’re pretty close financially I think when it comes to past earnings, tenure and benefits, so I can see how various scenarios would play out if I took the same route. Funny “soul-sucking” term, that’s how many Americans feel!

  • Nick August 8, 2012, 10:51 am

    I’ve been struggling with what to do re: projecting my ss benefits. I’ve decided to aim for no social security with my projections, not because I’m a conspiracy theorist, but I’d rather be overprepared (and leave a bunch to my kids) than under. So this way I have the worst case covered. I’m almost 34, so a lot can happen between now and retirement age (whatever that will be when I hit my 60s…). 🙂

  • jefferson August 8, 2012, 1:58 pm

    Like many others, when considering my retirement.. I just assume that social security won’t be there… The solvency numbers that I have heard over the years lead me to believe that this is pretty much inevitable without major changes..

  • Ornella @ Moneylicious August 9, 2012, 1:47 pm

    It’s great that you looked into this. Social Security was not meant to replace your income. And based on the formula for calculating one’s Social Security benefit, the more money you make the less you actually received. Besides, with full retirement age increase to 67 (and it might further increase) that will be a little damper on retirement. All retirement account allow you access (penalty free) starting at age 59 1/2. There’s at least 7.5 years to wait until you can touch Social Security, and that’s under current law. Therefore, as you know, retirement and financial future’s success is completely on your shoulders.

    • retirebyforty August 9, 2012, 10:27 pm

      Social security was meant to work in tandem with personal saving and pension. Unfortunately, many people do not have either of those things. It’s a tough living if you have to depend on social security benefit alone.

  • Naomi June 11, 2013, 1:15 pm

    Are those benefit amounts in today’s dollars?

    • retirebyforty June 11, 2013, 10:30 pm

      They get a cost of living adjustment periodically. I’m not sure if this is reflected in the projected number. It’s all academic until you receive the benefit anyway. I’ll research a bit more. Thanks for pointing this out.

  • The Green Swan April 25, 2016, 4:25 am

    This is a good primer on SS, Joe, thanks for re-posting. I’ve never paid much attention to SS since I figure I won’t get much if any benefit from it, I’m 30 right now. I expect Congress will eventually fix it to keep it solvent, but I’m not counting on it for myself in retirement to be safe. But it is good to hear that our personal SS estimates can be found easily online now, I’ll have to take a look.

    The Green Swan

    • retirebyforty April 25, 2016, 10:06 am

      I think you’ll still get some Social Security benefit. I’m sure Congress will reform it at some point. A lot of retirees depends on Social Security benefit and they won’t be able to ignore those voters.

  • Chris @ Apathy Ends April 25, 2016, 4:53 am

    Glad you reposted this, I didn’t know how benefits were calculated.

    Like The Green Swan, I am not counting on social security, I am 29 and assuming the retirement age can is going to get kicked along with the rest of it.

  • Andy April 25, 2016, 6:38 am

    I always thought it was the best 20 years. Didnt know it was 35.

    • retirebyforty April 25, 2016, 10:07 am

      Yeap, 35 years is a long time to average your income. However, once you get near the 2nd bend point, the benefit starts to decrease quite a bit.

  • FinanceSuperhero April 25, 2016, 7:20 am

    This is easily one of the best explanations of how Social Security really works. I was just trying to explain all of this to my father, who is possibly going to retire prior to 67 in a few years. I may send this to him, as I think the graphs will demystify the issues for him.

    • retirebyforty April 25, 2016, 10:08 am

      Thank you! Tell all your friends about this post. 🙂

  • Sandy April 25, 2016, 9:48 am

    I have often wondered what the SS cost of retiring say at 57 instead of at 67 after at least 35 years of full time work would very specifically. It doesn’t sound like much, even though 10 higher earning years would theoretically be replacing 10 lower earning years. The SS calculator seems to assume that if you stop working before 62 you automatically start collecting SS at 62. Would like to consider a 57 retirement, 67 collect SS benefits scenario, assuming that a small pension and personal savings will get me through this early retirement period.

  • AmyB. April 25, 2016, 12:13 pm

    I don’t believe social security will ever disappear. The news reports that 34%-65% of seniors live off social security for 50%-100% of their income. If there was no Social Security, many of them would fill the Welfare rolls needing food and housing assistance.
    Sure the age will increase and the amount we contribute will as well, but Americans as a whole are not the best savers/planners, so I don’t expect it to be eliminated.

    Plus what brave Congressman is going to submit radical changes for Social Security knowing they are assured to lose his/her job. Their mantra is Job one is to keep your job.

    • retirebyforty April 25, 2016, 12:33 pm

      I’m sure Congress will get their act together at some point. It’s easier to kick the can down the road for now, but in a few years they won’t be able to ignore the problem anymore. I read that raising the cap rate would help a ton. That seems like the most painless step to me.

  • Justin April 25, 2016, 3:28 pm

    Even though I only worked full time for 10 years, I’ll still be getting over $10,000 per year from SS at regular retirement age. Same for Mrs. RoG. $20,000/yr won’t quite cover our living expenses but it should cover most of the core expenses (housing, food, transportation) so as long as we have just a little left in our investment accounts by then, we will be totally fine financially.

    Though I know a more likely scenario is that our investments will remain flat or grow slightly over the years to the point that we don’t need SS at all. Then it’ll probably fund grandkids’ college or fun extended family trips or go to charity.

    • retirebyforty April 26, 2016, 10:02 am

      Now that you mention it. It’s pretty amazing that you worked only 10 years.
      It looks like you’re right near the 1st bend point. You could still increase your Social Security benefit by just working 10 more years. 🙂
      I’m hoping we won’t need Social Security either, but you never know how things are going to turn out.

  • The Jolly Ledger April 25, 2016, 3:53 pm

    Joe, we are about the same age so we should be going through the same issues with SS in the future. My projected monthly benefits for age 67 were $1,946 assuming I retire at age 45. If I wait until age 70 to collect, my monthly benefits increase to $2,413. I haven’t calculated my spouse’s benefit since he has had very low income his whole working life, but I am now curious since it looks like SS benefits the low income worker more! Thanks for updating.

    • retirebyforty April 26, 2016, 10:02 am

      You should check your spouse’s benefit. You might be pleasantly surprise.

  • Alan April 25, 2016, 3:57 pm

    Social Security but there is an insidious ways the Government will adjust it so that they have money. In fact its already happening. The estimated benefits are in today’s dollars and adjusted for inflation every year, or so they say. In 2016 the adjustment is 0% because they say there is exactly zero inflation, but I don’t know about you, but I see prices increasing. If the inflation adjustments are a bit less than inflation every year, they are effectively lowering payouts a bit every year. They will simply let inflation do their dirty work. The younger you are, the more you will get hit.

    • retirebyforty April 26, 2016, 10:03 am

      You’re right about the COLA. 0% inflation is not true. The cost of grocery alone increased quite a bit every year.

    • jim April 26, 2016, 11:36 am

      The COLA system for Social Security works kind of goofy, but its not just the govt. making up numbers to screw over the old people. They compare the CPI-W of the 3rd quarter of the most recent year versus the previous years 3rd quarter. So to figure 2016’s adjustment they’d look at Q3 of 2015 vs Q3 of 2014.

      Remember how gasoline prices plummeted in the past year? That wasn’t just gasoline it impacted other energy too (home heating, etc) All energy costs were down ~10% in just January 2015. That caused the CPI-W to go down 0.7% in that month alone. So comparing Q3 of 2015 to Q3 of 2014 included the impact of the drop in energy prices.

      So as it works out Q3 of 2015 to Q3 of 2014 for the CPI-W was flat.

      This is how SS COLA has worked since 1972. There are also years when SS COLA goes up more than CPI would generally indicate. The broader CPI is CPI-U and in 2007 it was up only 4.1% but then in 2008 SS COLA went up 5.8%. If you average CPI-U annual increases over the past 10 years they are 1.86% and SS COLA increase averages at 1.99%.

      Arguably CPIW Q3 vs Q3 is not a great way to do it. They should look at the entire year increases for CPI-U as a better measure. But if they did… average SS COLA would be lower.

      • retirebyforty April 27, 2016, 10:38 am

        Thank you for the clarification. I thought CPI doesn’t count gasoline. 🙂

  • Mandy April 25, 2016, 7:13 pm

    Very helpful. I plan to retire before 55 and have yet to check impact on future SS payments… This is excellent primer and the calculations tell me I don’t have to worry too much about how retiring early is going to impact my SS payments.

    • retirebyforty April 26, 2016, 10:04 am

      I don’t think you have to worry much at 55. You’d have 30+ years of earning already. The benefit shouldn’t change much for you. Thank you for the encouragement.

  • clarice April 25, 2016, 9:44 pm

    If I retire early, Will I be able to hold at least a part-time job?

    • Alan April 26, 2016, 11:24 am

      If you are younger than full retirement age this year, and you work while receiving Social Security, you will lose $1 from your benefits for each $2 you earn above $15,720.

  • nicoleandmaggie April 26, 2016, 9:52 am

    I dunno, $700/mo in perpetuity looks like a pretty substantial difference to me, especially off a base of less than $2000 — that’s more than a third of the baseline benefit.

    • retirebyforty April 26, 2016, 10:06 am

      25 more years of working would be perpetuity for me. 🙂

  • Dividendsdownunder April 26, 2016, 3:35 pm

    Very interesting to read about, thanks for sharing Joe. Australia is completely different, it’s interesting to see the differences.

    Tristan

  • supernova72 April 26, 2016, 3:48 pm

    I’ve messed around on the ssa.gov site a few times. My estimate at 62 yrs assumes I work until 62 so I was trying to do different scenario’s say retiring at 56 or 57. Now I can’t seem to find that calculator? Think it’s a senior moment on my part.
    At 62 it says $1810 a month…

  • AW May 7, 2016, 1:37 pm

    This had been on my list of curiosities but I had only lightly researched. You are doing a great job of filling gaps in my understanding and perspective, and doing it artfully! Love it

  • David Michael May 17, 2016, 8:51 am

    Great topic Joe, once again. OK…I’ve been retired for over 22 years and I’ll give my take on Social Security present and future. In a few months I’ll be 80, twice your age 40 take on retirement.

    1) In referring to many of the comments to your article, I am a bit surprised by the negativity and “give-up” attitude of your younger readers. Social Security is one of the main legs of any retirement program in this country as well as most developed countries around the globe. I fully expect SS to be alive and well 20-40-60 years from now by eliminating the cap and possibly increasing the age limit by one or two years as longevity improves. It is important that each of us focuses on working with our Congressional Representatives and fight to keep SS healthy and fully funded. Our military expenditures over the last 20 years would have paid for SS plus universal health care. And…time to fire any do-nothing Reps who work for the 2% rather than the 98% of us that make up this country.

    2) While everyone is madly putting away money for retirement, here are a few hard facts out there in the game of life. There’s a 50% chance you will lose half of your nest egg to a divorce. A lot of divorces come after the children have been raised and women in particular want their freedom. Fortunately, Social Security provides a backup for each spouse. It is not unusual for the highest earner to pay lifetime alimony to the other spouse (usually to the wife).

    3) The stock market, despite the wonderful world of quarterly dividends, can be a cruel place. It’s quite conceivable that a severe downturn could last 10-20 years. Thus, the reason for being well diversified over several different financial areas. I lost over $500,000 in a theorectical safe investment called an annuity when the company went bankrupt. Unusual but it happens.

    4) I fully expected to have a retirement income of $9000 a month. Instead, we have $3000 due to the above. Fortunately, we have created a great retirement nonetheless, but one of the main reasons was Social Security. Do not let politicians scare, deceive or spend you out of one of the most important programs in this country.

    • retirebyforty May 17, 2016, 9:44 pm

      I think Social Security will be around as well. Congress will have to reform it at some point. Voters won’t let them run it into the ground.

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