Among life's big timing decisions are when to buy a home, when to start a family, and when to retire. All three have their complexities, but choosing a target retirement date can leave you feeling especially conflicted. An early retirement gives you more time to enjoy the work-free lifestyle. But it also comes with financial constraints -- including a lower Social Security benefit.

Even so, the trade-off might be worth it. Before you decide, read on to find out how early retirement changes your Social Security income, and what you can do to make up for it.

Senior couple walking on the beach, holding hands.

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The cost of claiming early

You can claim Social Security as early as 62, but your benefit is reduced when you claim before reaching Full Retirement Age (FRA). FRA is assigned to you according to your birth year, and yours will be somewhere between the ages of 66 and 67. Your early-filing reduction will be calculated according to the number of months before your FRA that you start receiving benefits. Specifically, your benefit is lowered by five-ninths of 1% for each of the first 36 months prior to FRA. Beyond 36 months, the benefit is scaled back by five-twelfths of 1% monthly. If your FRA is 67 and you want to start receiving benefits right around your 62nd birthday, you'd calculate the reduction like this:

  • You're claiming five years early, which translates to 60 months.
  • For the first 36 months, multiply five-ninths of 1% by 36. That equates to 20%.
  • For the remaining 24 months, multiply five-twelfths of 1% by 24. That gives you another 10%.
  • Add the 20% and 10% together to get a total reduction of 30%.

Looking at the average Social Security benefit at FRA of about $1,500, a 30% cut would reduce that amount by $450 to $1,050 per month.

How to retire early anyway

A 20% or 30% decline in retirement income is a lot, but you can make a lower benefit work by planning ahead. You'll likely need to attack the shortfall from both sides -- by lowering your living expenses and increasing your retirement income. You can often find the largest expense reductions in your debt. Aggressively pay down your high-rate credit cards and look to pay off or refinance your mortgage. After those big moves, there are many other, smaller cost-cutting measures to take, such as cancelling subscriptions, shopping around for cheaper car insurance, and cooking more meals at home.

Investing for passive income

Whittling down those expenses now, before you retire, should free up cash that you can then invest for passive income in retirement. You can earn passively in a variety of ways, but dividend income is particularly appropriate for retirees. Unlike small business income or real estate rents, dividend income requires very little work on your part. Plus, the right dividend-paying securities will provide you increasing income as well as gains from share price appreciation.

The next obvious question is, how do you identify the right dividend-paying securities? First, decide if you feel comfortable picking stocks or would prefer to invest in mutual funds or exchange-traded funds (ETFs). Funds are already diversified, which means you'll have fewer to manage versus individual stocks. The downside is that funds charge fees, and fees lower your returns. For that reason, you should look for funds with very low expense ratios, something lower than 0.2%. As you can see in the table below, Vanguard, iShares, and Invesco all have dividend ETFs with expense ratios below 0.1%.

Fund Name

Expense Ratio

SEC Yield

Net Assets

Vanguard High Dividend Yield ETF (NYSEMKT:VYM)


3.62 %

$33.94 billion 

iShares Core High Dividend ETF (NYSEMKT:HDV)



$5.82 billion

Invesco Dow Jones Industrial Average Dividend ETF (NYSEMKT:DJD)



$118.7 million

Beyond the fund's expense ratio, you'll also want to review the portfolio, investing approach, performance history, size, and the all-important dividend yield. Dividend yield is fund's annual dividend income as a percentage of its share price. Look for the fund's SEC 30-day yield. This is a standardized yield metric that you can use to compare one fund to the next.

If you'd rather invest in dividend-paying stocks, plan on reviewing the company's history of paying and increasing its dividend. You might start by researching Dividend Aristocrats -- these are S&P 500 index companies that have increased their dividend for at least 25 consecutive years. You'll see many names you recognize, such as 3M (NYSE:MMM), AT&T (NYSE:T), McDonald's (NYSE:MCD), and PepsiCo  (NASDAQ:PEP). Current dividend yields for Dividend Aristocrats range from less than 1% to more than 7%.

Setting your goal

Whether you choose stocks or funds, you can use the yield to estimate how much of the position you'll need on hand to cover your income shortfall. Let's say you've estimated that retiring early will shrink your Social Security income by $400 monthly, or $4,800 annually. And you've identified a dividend portfolio that should pay you about 3%, based on current yields. Divide the $4,800 by 3% and the answer, $160,000, is how much you need to invest in that portfolio to produce income of $4,800 per year. Note that the $160,000 would be in addition to any retirement savings you already have -- unless you plan to survive entirely on what would've been your Social Security benefit at FRA.

Plan now to retire early

The last step is to use a compound interest calculator to determine how much you should save monthly to reach your goal by your retirement date. If the calculator returns a savings contribution that feels impossible, then save as much as you can instead. That way, you can start building momentum now. You can always increase your savings contributions later as your income goes up or as you continue trimming down your living expenses.

Retiring early is expensive, but not impossible. Plan ahead, keep your expenses lean, and start investing for future dividends right now. That's how to get the best of both worlds: a longer retirement that's also financially secure.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.