How a Social Security benefit is calculated (Part 2).
By Duane J. Silbernagel
Last week we discussed the intricacies surrounding how a Social Security benefit is calculated. This week we will discuss options available for individuals who may want to take a benefit early.
Filing at 62
With very few exceptions, filing at 62 years old is an option for any individual who meets the criteria outlined last week for a Primary Insurance Amount (PIA). This is the youngest (again, with a select few exceptions) that one can file for a Social Security benefit. Social Security was established, in 1935, the premise that one would retire at the designated Full Retirement Age (FRA). In 1956, age 62 became a retirement option for women and in 1961; it became an option for men. Some industries carry a heavier toll, over a workers career, than others as far as stress on the body. To help with those who truly wish to retire and live off of savings, Social Security allows for “early” filing. The idea behind that if making this election, the individual stops working (or having an income subject to Social Security tax). In order to ensure this, Social Security has an earned income limitation that is indexed every year. In 2015, if you are under FRA that number is: $15,720. If an individual is collecting Social Security and earns more than $15,720, the reduction in benefit is $1 for every $2 in excess. The most common question when asked about this number: is this number gross or net? This is all earnings that are subject to Social Security taxation. The real question becomes: does it really matter? If considering retirement and the need to work may exist, why tempt fate? There are things that are beyond an individual’s control. Something as simple as an end-of-year bonus could throw a complete curveball into this whole scenario.
Let’s take a step back to think about the concept of Social Security. As one progresses through your working career, he or she pays into the Social Security pool of money. So, essentially, there is a pool of money that is funding the Social Security retirement benefit. The Social Security Administration factors into this a life expectancy component as well. Back to the pool of money that represents the working lifetime benefit, if these funds are accessed early – between 62 and FRA – the benefit received will be a smaller monthly amount, as that pool of money has to stretch farther to cover life expectancy.
So how does the Social Security Administration calculate the reduction?
The information shown below can be cumbersome to crunch through; I’ve simplified the reductions in Table 1 below, calculated to starting a benefit at age 62, and based on the year of birth. Look up a birth year and multiply the PIA by that factor.
Table 1 – PIA Reduction at age 62, based on Year of Birth
The formula to calculate this is a two-tiered formula that is predicated around how many months prior to FRA the individual retires:
36 months or less; and
Greater than 36 months
This formula is based on number of months until FRA is reached, every month that is delayed in taking the benefit, the monthly benefit increases slightly.
When deciding on whether to take Social Security early or not, life expectancy is a key point to consider. Individuals are living longer in retirement now. If retiring at 62, one may have another 30 years ahead. At some point, longevity allowing, taking the benefit at FRA will pay – cumulative lifetime benefits – more than filing at 62. Those ages are listed below, based on year of birth.
Table 2 – Approximate Age of Cumulative Lifetime Benefit Breakeven, FRA vs. 62
Factoring in personal health and family history become an important consideration as well. Is it plausible to outlive the breakeven age? If so, consider waiting until FRA as Social Security will pay more once you exceed that age.
No one knows what the future of Social Security is. Taking the benefit early may be a good fit for one particular situation. If an individual is planning to work in retirement, there are some concerns or drawbacks, such as the earned income limitations.
What we do know, is that the more money Social Security pays, the less personal assets that will be required to be accessed. Potentially extending the timeframe those funds are available.
I hope you find this information as beneficial and intriguing as I do. Having my engineering background, I love to get into the numbers and calculate the data out. Please do not become overwhelmed. I understand that not everyone is as detailed. I try to simplify the topics to a point that suits both the uninterested person and those who yearns to create a seven tab spreadsheet to capture all possible scenarios that play out for their situation. These calculations can get confusing and complicated, very quickly. While it may or may not be important – to you personally – to understand the mathematics behind the benefit, it is vitally important to make sure the accuracy of earnings reported to the Social Security Administration, as I closed with last week. Check your statements against your tax records and W2 income against the historic payroll tax liability.
Next week we will expand on Social Security by looking at the factors that go into delaying the filing.
If you’d like to review your Social Security benefits with me visit my website: www.duane.wrfa.com. You’ll find numerous ways to contact me.
Thank you for reading.
The tables shown herein are based on complicated calculations. These calculations