The last time lawmakers amended Social Security rules, it was 1983. That was the year Culture Club's Karma Chameleon reached No. 1 on the U.S. Billboard Hot 100 and Cabbage Patch Kids set a new standard for holiday toy mania. Now, 37 years later, Boy George has cut his hair and you can buy Cabbage Patch Kids on Amazon (NASDAQ:AMZN). And yet, Social Security remains largely the same -- and that's problematic, according to new research.
Researchers at Boston College have concluded that low-income individuals may not be getting their fair share of Social Security benefits. The disparity is related to how benefits are affected when you claim before your Full Retirement Age (FRA).
How early Social Security claims work
Your full Social Security benefit is based on your average income in your highest-paid 35 years of working. That full benefit is available to you at your FRA, which is between 66 and 67, depending on what year you were born. You do have the option to claim your benefits earlier or later than FRA, in exchange for an adjustment to the amount you receive. Delay claiming and your monthly benefit is increased. Claim early and your monthly benefit is reduced.
It's that downward adjustment for early claims that's under scrutiny. Here's how the adjustment works. Let's assume you want to claim at age 63, and that is 52 months before your FRA. Your monthly benefit will be reduced by a small percentage for each of those 52 months. As shown in the table below, the exact percentage used depends on how many months before your FRA you claim. Note that you cannot claim prior to age 62, which is at most 60 months before you reach FRA.
Number of Months Prior to FRA That Benefits Are Claimed
1 to 36
5/9 of 1%
37 to 60
5/12 of 1%
In our scenario of claiming 52 months prior to FRA, the reduction would be:
- 5/9 of 1% multiplied by 36 months (equal to 20%), plus
- 5/12 of 1% multiplied by 16 months (equal to 6.67%)
That equates to a monthly payment that's 26.67% lower than your full Social Security benefit.
Claiming early may also reduce your lifetime benefit
The reduced benefit for claiming early is by design. In theory, claiming 52 months before your FRA should give you 52 extra payments over your lifetime. Each payment may be smaller, but the sum of those payments -- your cumulative lifetime benefit -- should be the same, whether you claim before your FRA or not.
Unfortunately, as the research shows, that's not the way the formula works today. Specifically, Boston College researchers found that the average beneficiary who claims at 62 gets only 94% of the lifetime benefit versus claiming at 65. Even more disturbing is that low-income individuals are more likely to experience that lower lifetime benefit.
Life expectancy discrepancies
Two factors explain why low-income recipients tend to receive reduced lifetime benefits. First, low-income individuals are more likely to claim their Social Security benefits early -- which reduces their monthly benefit. And second, low-income individuals have a lower life expectancy than higher-income folks. A shorter lifespan means fewer payments and even more downward pressure on that lifetime benefit.
Higher-income individuals, on the other hand, benefit from the other side of these trends. They can afford to wait until FRA and beyond for that larger monthly payment. And they're more likely to live longer, which translates to a greater number of payments over their lifetime.
Claiming late doesn't affect lifetime benefits
Interestingly, Boston College found that delaying Social Security past FRA doesn't affect lifetime benefits significantly. When you delay claiming, your monthly benefit amount increases 3% to 8% for every year beyond your FRA, until you reach the age of 70. Although those monthly payments will be higher, you'll likely get fewer payments. The end result is usually a lifetime benefit that's about the same as what you would have received if you'd claimed at FRA.
Maximizing your lifetime Social Security benefit
The decision of when to claim your Social Security benefits is a personal one. If you can't afford to wait until your FRA, go ahead and claim. You can still take steps to maximize your lifetime Social Security benefit -- make it your mission to buck the system by living healthfully and outliving the average life expectancy of your peer group.
If you have a decade or more to choose a Social Security claiming strategy, up your contributions to your retirement plans now. Challenge yourself to save as much as possible. There's no telling how Social Security might evolve in the next 37 years. But you can count on this: A higher savings balance always gives you more flexibility on the timing of your benefits claim.