Social Security plays a big role in the lives of senior citizens. Roughly $944 billion was apportioned for the Social Security program by Congress in 2016, which covers benefit payments to more than 60 million people, roughly two-thirds of whom are age 62 or older.
Despite the Social Security Administration's (SSA) suggestion that retirees count on Social Security benefits to replace, on average, about 40% of their wage income, a majority of seniors actually rely on Social Security to provide the bulk of their month-to-month income. Gallup's poll results showed that just shy of 60% of seniors rely on Social Security to be a major part of their monthly income, while a June 2015 Fact Sheet from the SSA found that 53% of married couples and 74% of unmarried persons received 50% or more of their income from Social Security.
With seniors leaning heavily on the program, it's important that they understand the ins and outs of what can net them the biggest payments, or the best possible value, over their lifetime. This starts with essentially the biggest decision you'll make in your golden years: when to claim benefits.
Understanding when to claim benefits
The first thing retirees need to figure out is when they'll hit their full retirement age, or FRA. A person's FRA is a dynamic figure based on their year of birth that determines when they're eligible to receive 100% of their benefit. For baby boomers, we're talking about an FRA that could range from 66 years to 67 years. What this means is that anyone taking benefits before their FRA is going to receive less than 100% of their full benefit, while waiting to claim until after your FRA will boost your monthly benefit above 100%. The reason Social Security benefits are set up this way is that your benefits increase by roughly 8% for each year that you forgo claiming.
For example, claiming benefits at age 62 with an FRA of 66 (which covers people born between 1943 and 1954) means receiving as little as 75% of your FRA. Given that the average retired worker benefit in the May SSA snapshot was $1,347.59, this would mean accepting an average monthly payment of just $1,010.69 for the rest of your life. Conversely, waiting until age 70, the age at which annual benefit increases stops, would yield 132% of the FRA for seniors born between 1943 and 1954. Using the same May snapshot, we'd be talking about an average benefit of $1,778.82 for life.
Waiting means a higher payment, but roughly 3 in 5 seniors files for benefits prior to reaching their FRA, including about 45% who do so when they turn 62.
When filing early is a big mistake
Is this a mistake? Not necessarily. There are some perfectly viable reasons to file for benefits at age 62. For instance, if you're not in good health, you'd probably prefer to take your benefits earlier rather than later. If you've saved far more than you'll ever need for retirement, and Social Security income is more of a means to pursue your travel plans or passions, then claiming early makes sense, too. Early filing can also be a smart choice for couples in which one spouse earned substantially more than the other. Allowing the higher-earning spouse to hold off on filing lets that person's benefit grow, while the lower-earning spouse can claim at age 62 and provide at least some monthly income to the household.
But there's one instance where filing for benefits early can be a critically bad mistake.
If you're entering your golden years with nothing saved for retirement, or perhaps only a small sum saved, it might seem tempting to file for benefits as soon as you turn 62 to get monthly income streaming in. Unfortunately, this could prove to be a big mistake. You see, there are two factors working against you if you have little or nothing saved for retirement and you claim early.
First, if you happen to continue working while receiving benefits, and you also haven't hit your FRA yet, the SSA can withhold some, or all, of your benefits. In 2016, if you file for benefits before your FRA, the SSA limits your full-year earnings ability to just $15,720. For each $2 earned in excess of this amount, $1 will be deducted from your benefits. If you happen to reach your FRA sometime this year, but aren't quite there yet, the SSA is a bit more lenient, allowing you to earn up to $41,880 before deductions begin. Should you surpass this mark, the SSA will deduct $1 in benefits for every $3 earned beyond $41,880. Once you reach your FRA there are no more earnings limits, and the benefits withdrawn will eventually be repaid to you after hitting your FRA in the form of a higher monthly payment. But for those expecting a monthly income boost for filing early, they could very well be disappointed.
The even bigger issue is that filing early with insufficient savings means accepting a lower payment for life. If you don't have alternative sources of income, the best move is actually to wait as long as possible to file for benefits so you can maximize what you receive during retirement. This means making the choice to work longer (if possible), and allowing your wages to cover your month-to-month expenses.
A 25% haircut from your FRA is even scarier when taking into account that the Social Security Board of Trustees is forecasting that the Trust could burn through its spare cash by 2034. Should this happen, a benefits cut of up to 21% may be needed to sustain the program through 2090. In other words, your reduced payment could be even further reduced.
Furthermore, Social Security benefits have been losing purchasing power against rapidly rising healthcare costs. If you haven't saved much, or anything at all, prior to retirement, you could find that Medicare premiums and expenses could eat up most of your benefits.
If you're nearing retirement and you haven't saved much, consider working longer or using what you have saved for retirement to cover your month-to-month expenses in order to allow your Social Security benefits to grow.