Social Security's importance for seniors during retirement simply cannot be understated. Though it's a program that can potentially be out of sight, out of mind until we hit our 60s, it nonetheless provides at least half of all annual income for more than 25 million current retired workers. If we didn't have Social Security, senior poverty rates would probably skyrocket.
But this important program has a bit of a dark secret: It's not on the best financial footing. According to the Social Security Board of Trustees, the Social Security Trust Fund will begin paying out more in benefits than it generates in revenue via payroll taxes, interest earned on its asset reserves, and through the taxation of benefits, by 2020. Some 14 years later, in 2034, the Trust's $2.85 trillion in spare cash will be gone, perhaps necessitating a cut in benefits of up to 21% for current and future retirees. It's a pretty unnerving forecast considering how many seniors rely on Social Security as their major income source.
It's time to be proactive, America
While we can all cross our fingers and hope that Congress provides a workable Social Security fix for current and future generations, we simply can't count on lawmakers to get things done. Instead, we have to be proactive about maximizing our benefits.
Three factors, in particular, decide what you'll be paid by the Social Security Administration (SSA) during your golden years. Two of those three factors are interconnected: your earnings history and length of work history. The SSA will take your 35 highest-earning years into account when tabulating your monthly benefit, which obviously provides an incentive for you to earn as much as you can, and work for 35 years, if not longer, to avoid dragging down your benefit.
The third factor is arguably the most important: when you decide to claim benefits. The SSA allows seniors to begin taking Social Security benefits as early as age 62, but there's a major incentive to hold off. For each year that you pass on enrolling for benefits, your payout grows by about 8%. This continues up until age 70.
Essentially, a person with identical work and income history claiming at age 70 could have up to a 76% higher payout than a person claiming at age 62. In short, waiting pays.
The most important Social Security chart ever
But it also pays to understand when you'll hit your full retirement age (FRA), since your FRA really determines your monthly benefit. Your FRA is the age at which the SSA determines you eligible to receive 100% of your due benefit, and it's determined by your birth year. By 2022, anyone born in 1960 or later will have a full retirement age of 67 years. Claim before your FRA and you'll receive a permanent reduction to your benefit. Wait until after your FRA and you'll net an even larger payout.
Common sense would suggest that most seniors are waiting as long as possible to claim Social Security benefits, right?
Wrong! So, so wrong.
As you can see above in what could arguably be described as the most important Social Security chart you'll ever see, the vast majority of seniors (60%) claimed Social Security benefits between the ages of 62 and 64, with another 30% claiming at their full retirement age. The remaining 10%, based on data from the Center for Retirement Research at Boston College in 2013, claimed after their FRA, with a meager 3% waiting as long as 70 to receive the largest benefit possible based on their incomes and work histories.
Should you claim earlier or later?
People who take Social Security benefits as soon as possible, which, as you can see above, represents 45% of all seniors, are accepting a permanent cut in benefits of between 25% and 30%. Considering that another benefits cut of up to 21% (per the Trustees) looms large in 17 or fewer years, this puts nearly half of all seniors at risk of a major financial crisis during their golden years.
It's worth noting that taking benefits at age 62 does make sense in certain scenarios. For instance, if you're in poor health, there's no sense in waiting until later to begin taking benefits.
Another example would be seniors who are having trouble finding work and/or generating income. Signing up for Social Security might be their only recourse to generate monthly cash. Lower-earning spouses may also benefit from an early claim since it'll generate income for the household while the higher-earning spouse's benefit grows at 8% annually.
However, waiting is often preferable, but so few are heeding that advice based on the data. Even if a worst-case scenario occurs and benefits are cut in or by 2034, those who've waited and secured a higher payout may still be able to meet their personal expenses.
When does waiting make sense? If you have little or nothing saved for retirement (ahem, baby boomers), your most prudent move is to wait on filing a claim for as long as possible since you're liable to be reliant on Social Security during retirement. If you're healthy, waiting often makes sense, too. While no one knows his or her expiration date, your personal health and that of your immediate family can aid in your decision.
Finally, higher-earning spouses should consider waiting, since the growth of their benefit can have a sizable impact for a couple during retirement. Waiting could also mean a larger survivor benefit for a spouse or younger children should a primary retired worker pass away.
If this age distribution has demonstrated anything, it's that seniors need to retrain their thinking. Though there are clear reasons for filing early, it's unlikely that 60% of seniors -- or perhaps even more now with FRAs on the rise -- are benefiting from an early claim.