For the average wage earner, Social Security could replace 40% of your working income. And if you don't have any other guaranteed income sources, this benefit could be a major lifeline during retirement.
It is for this reason that you should attempt to max it out. Here are three ways your Social Security payment could get reduced and how you can prevent it.
1. Not earning enough before retirement
You qualify for Social Security if you earn 40 work credits. As of 2021, $1,470 in earned income gets you a credit and you can earn up to four credits each year. While this earnings amount will make you eligible, it probably won't result in a big payment. But there are a couple of ways that you can increase it -- by working more years, earning more money, or both.
Your average indexed monthly earnings (AIME) is how your benefit payment is calculated and considers your highest 35 years of earning wages. One thing that can decrease your payment is not working all of these years because you will have times when you have no income going into your calculation. For example, if you earned income for 25 years, the amount of money that you made in those years will count toward your benefit calculation, and the 10 years where you did not earn an income will count as zeros. Making sure that you have no zeros or as few as possible can help push your average up.
How much you make can also increase your AIME. Earning annual raises is one way that you can accomplish this, but may not be in your control. If earning a higher salary or hourly wage isn't possible each year, you can potentially earn more by working more hours at the same job or by working an extra job part-time or finding gig work.
2. Taking your payments early
Your full retirement age (FRA) determines your standard benefit but you can take Social Security as early as 62. Taking it early may help you pay bills, but comes at a cost as your benefit is reduced for every year that you take it early. If you take Social Security at 62 and your FRA is 66, your benefit will be lowered by 25%. So if your standard benefit is $2,500, your reduced monthly benefit will be $1,875. This $625 difference in benefit could have a huge impact on your lifestyle and over the course of a year amounts to $7,500 less in income.
There are times when delaying your benefit does not work out in your favor. If you have health issues and may not have a long life expectancy, you can potentially draw more income from this system over your lifetime by taking it early. You may also need the money and can't steer clear of taking it early. But if you do have a family history of longevity and can survive financially without taking it early, waiting can increase your monthly benefit.
3. Too much work income before reaching full retirement age
If you make it to your FRA, you can work as much as you want while receiving Social Security without having it impact you in a negative way. But before this age, your benefit payment may get dinged if you continue earning an income. If and how much depends on how much you earn. For 2021, the earnings limit is $18,960, or $1,580 a month.
For every $2 that you earn above this limit, your benefit will be reduced by $1. So if you are under your FRA and earn $1,500 in a month, your benefit will not be further lessened. If however, you earn $2,000, your benefit will be reduced by $210.
In the year that you reach your FRA, this calculation is a little different. Up to the month before you reach your FRA, you have an earnings limit of $50,520 or $4,210 a month in 2021. And for every $3 you make above this limit, your benefit is reduced by $1. If you earn $4,000 a month, you won't see a reduction, but if you make $5,000, you will receive $263.33 less benefit each month.
If you need the extra income from Social Security or if you take the income because you don't anticipate a long life expectancy, circumventing this may be impossible. But if you have the flexibility and are working because you enjoy it, limiting your income after you've started taking Social Security is one way that you can bypass this reduction.
Social Security is a source of income that could on average pay up to 40% of your bills in retirement. And reductions to it could affect your lifestyle in retirement. But there are actions that you can make before you start taking it, when you are preparing to take it, and after you've started taking it that can affect how much you receive.