I 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.
- 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.
- 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.
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.
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