Most people understand that Social Security is a government program they pay into throughout their working lives in exchange for guaranteed monthly payouts in retirement. But if you press them for more specifics on how it works, they'll probably draw a blank. A recent Nationwide survey found the vast majority of people cannot correctly answer the three Social Security questions listed below.
It's OK if you don't understand everything about Social Security, but you should know how to answer these questions before signing up for benefits. Misunderstanding these key concepts could cause you to claim benefits at the wrong time and cost yourself money.
1. At what age do you become eligible for your full Social Security benefit?
The age at which you become eligible for full Social Security benefits is called your Full Retirement Age (FRA). FRA varies depending on the year you were born: Those born between 1943 and 1954 have an FRA of 66. Then, it rises by two months every year thereafter until it reaches 67 for all adults born in 1960 or later. To ensure your exact FRA, reference this table from the Social Security Administration.
FRA is designed to be the age at which you claim the standard Social Security benefit to which you're entitled based on your work history. However, you can elect to start receiving benefits as early as 62. If you do this, you'll receive smaller checks to account for the additional years you're receiving benefits. For example, those with an FRA of 67 will only get 70% of their standard benefit if they claim at 62.
On the other hand, if you choose to delay Social Security benefits, you will receive larger checks when you do decide to claim. The value of your expected checks increases 8% each year you delay until you reach age 70, at which point you will have earned the maximum benefit check and there is no value in delaying any longer. This means delaying to age 70 would result in checks 124% larger than your standard benefit if your FRA is 67, or 132% if your FRA is 66.
2. Do your benefits increase at your full retirement age if you claim early?
Some people mistakenly believe their benefits automatically rise at their FRA if they begin claiming benefits at an earlier age, but this isn't necessarily true. When you begin Social Security, you're making a decision that's difficult to take back. You can withdraw your Social Security application within 12 months of claiming if you pay back all the benefits you've received thus far. But if you miss this window, you're locked in at your chosen rate for the rest of your life. Your benefits may rise slightly every year due to cost-of-living adjustments (COLAs), but don't expect to see a sizable jump at your FRA.
The one exception is if you have money withheld due to the Social Security Earnings Test. If you are claiming Social Security and are below your FRA for all of 2020, the government withholds $1 from your Social Security checks for every $2 you earn over $18,240. If you'll reach your FRA in 2020, it withholds $1 for every $3 you earn over $48,600 if you reach this amount before your birthday.
Once you hit your FRA, the Social Security Administration recalculates your benefits to give you back the money it withheld. This increases your benefit somewhat, but you may not get as much as you could have if you'd just delayed Social Security until your FRA or beyond.
3. What factors determine your maximum Social Security benefit?
- Average monthly earnings. Your maximum Social Security benefit depends on your average indexed monthly earnings (AIME). Your AIME is calculated as your total income over your 35 highest-earning years, adjusted for inflation, and then divided by 420 months (35 years) to get an average monthly income. (To be clear, there is an additional reduction following this called PIA -- however, you have no influence on this part of the calculation.)
- Zero-income years. It's best practice to work at least 35 years if you don't want zero-income years weighing down your benefit calculation. Working even longer than 35 years is smart if you're trying to maximize your benefit, because your lower-earning years will drop off as you have more higher-earning years to replace them.
- Annual income caps. High-income earners may be limited by the annual cap on income subject to Social Security tax. In 2020, only the first $137,700 you earn is subject to Social Security tax. Additional earnings won't increase your benefits.
- Delaying benefits. As discussed above, delaying benefits beyond FRA, at least until you reach 70, also increases your checks once you start collecting. If your goal is to get the most out of Social Security over your lifetime and you expect to live into your late 80s or beyond, delaying until 70 is probably your best move.
Now that you understand some of the basic factors that influence the size of your Social Security checks, you can start thinking about when you would like to claim benefits. Starting at 62 is a popular choice, but if you want the most money possible, you should at least consider delaying benefits for a few years.