Many Americans look forward to starting to receive Social Security at their earliest opportunity, jumping at the chance to get monthly payments by activating their retirement benefits as soon as possible. Yet many policymakers and government officials have urged more people to consider putting off claiming their benefits until later than age 62, and one little-known legal provision dating back to 1983 will come into effect next year. That provision will penalize people even more for claiming benefits early, and those who will turn 62 next year need to reconsider whether they're prepared for the consequences.
Why Social Security recipients will see a stealth pay cut starting next year
To understand what's happening to Social Security in 2017, you have to go back almost 35 years to the early 1980s. Back then, Social Security was going through one of its many financial crises, and policymakers worked hard to try to figure out a long-term solution that would keep the program solvent well into the future.
What lawmakers eventually agreed on was a series of substantial reforms. Raising the payroll tax rate and allowing trust funds to collect and hold excess payroll taxes were two of its key positions, but other changes led to future changes in the full retirement age. Beginning in the year 2000, those turning 62 in any given year saw their full retirement age rise by two months, hitting the current level of 66 in 2005.
Since 2005, the full retirement age has stayed stable. However, more changes begin taking effect in 2017, with further increases of two months per year eventually leading to the final full retirement age of 67 for those who turn 62 in 2022.
How much difference does a full retirement age of 66 and two months really make?
The 1983 provisions don't raise the minimum age at which you can claim early benefits, so anyone who wants to claim at their 62nd birthday will still be allowed to do so. However, the calculations impose greater reductions to your full retirement benefit than they would if your full retirement age hadn't gone up.
The formula for determining Social Security benefits imposes penalties on those who claim early benefits. For the first 36 months, you'll lose five-ninths of a percentage point per month you claim early. Beyond 36 months, each additional month costs you another five-twelfths of a percentage point. When the full retirement age was 66, then claiming at 62 meant getting your benefits 48 months early. That led to a penalty of 36 times five-ninths of a percentage point, or 20% for the first three years, plus 12 times five-twelfths of a percentage point, or an additional 5%. That adds up to a 25% reduction.
Going forward, however, claiming at 62 for someone who turns 62 in 2017 will mean claiming 50 months early rather than 48. That will cost an additional five-sixths of a percentage point, creating a 25 5/6% reduction.
An example will help put some perspective on the situation. Say that your primary benefit amount at full retirement age is $1,600. If you turned 62 in 2016 and chose to take your benefits immediately, then you would get monthly payments of $1,200. However, if you don't turn 62 until 2017 and make the same decision, your Social Security benefit will be slightly smaller, at just under $1,187 per month.
Small amounts add up
Few people will think twice about letting a $13 difference in benefits stop them from following through on their retirement dreams. However, it's still important to take that reduction into account, because it will have an impact on what you receive from Social Security for the rest of your life. Over the course of a 30-year retirement, even that minor difference will cost you well over $5,000 when you consider lost inflation adjustments. Moreover, those who turn 62 in later years will see even larger reductions compared to current Social Security recipients.
Social Security is important as a way for retirees to get the income they need, and claiming benefits early is a popular choice. But if you turn 62 next year and are looking forward to collecting Social Security, you need to take into account the fact that you'll get less in benefits than someone who was fortunate enough to turn 62 this year instead of in 2017.