In 2017, nearly one in every five U.S. residents received Social Security benefits, with retirees accounting for four in five of the 61 million beneficiaries. Social Security benefits lift 15.1 million seniors out of poverty and provide the majority of retirement income for 66% of beneficiaries.
While Social Security is the major source of income for more than half of all seniors, most people have limited understanding of how benefits work. In fact, mistakes about Social Security benefits are common and often cost seniors money. To make sure you don't make expensive errors, here are three big mistakes to avoid.
1. Misunderstanding the rules for retirement age
When responding to a Fidelity survey, only around a quarter of pre-retirees knew their full retirement age (FRA). Not knowing FRA is a big mistake because if you retire before it, your benefits are reduced (and if you retire after it, benefits increase until age 70).
FRA is based on your birth year, with FRA set at 67 for those born after 1960. If you retire less than 36 months early, your standard benefit -- the amount you'd get at FRA -- is reduced by 5/9 of 1% per month. If you retire more than 36 months early, benefits are reduced by an additional 5/12 of 1% for each earlier month. If you retire after FRA, benefits are increased by 2/3 of 1% monthly.
That means if you retire at 62 instead of 67 you face a 30% benefits reduction. This chart shows how your age of retirement affects benefits so you can make an informed choice. The benefit reduction lasts your entire life, despite the fact 39% of pre-retirees think benefits will increase at FRA if they were receiving reduced benefits after retiring early.
There are circumstances when it makes sense to claim benefits early. By delaying, you miss out on years of income, so you must live long enough for higher benefits to make up for forgone money. This formula to calculate your break-even point helps you determine how long you'll need to live to make up for delaying. If you're in poor health and don't think you'll survive that long, claiming early is smart.
However, you can make this assessment only if you actually know how your retirement age affects benefits -- and most people don't.
2. Not learning how Social Security benefits are calculated
More than nine in 10 older adults don't understand the factors that determine how much they can receive in Social Security benefits, according to a Nationwide survey. If you don't understand how benefits are calculated, you may inadvertently do something that reduces income you receive.
For example, Social Security uses a formula to calculate benefits based on your highest 35 years of earnings over your lifetime, adjusted for inflation. If you don't know this rule, you may retire before working 35 years without realizing years of $0 earnings will be factored in and drive your average wage down.
If you're earning a lot toward the end of your career, it may make sense to work for one or two more years so lower-earning years or years with $0 income are replaced by years when your salary is much higher. If you know Social Security considers 35 years of wages, you can make this informed choice and end up with higher benefits for the rest of your life.
3. Failing to consider spousal benefits
If you're married, widowed, or divorced after 10 years of marriage, you may be able to claim Social Security benefits on your spouse's work record rather than your own. This can make sense if your spouse earned more than you did.
However, many people don't really understand how spousal or survivor benefits work. In fact, a report revealed that 82% of Social Security beneficiaries entitled to both survivors' benefits and their own benefits weren't provided with information to make an informed choice. Many chose the wrong claiming strategy, and widows and widowers age 70 and over were underpaid by an estimated $131.8 million.
It's confusing to figure out how spousal benefits work. In a nutshell, you can file for spousal benefits when you're as young as 62, but can't receive a spousal benefit until your spouse has filed for his or her benefit -- unless you're divorced and your spouse is 62 or older. You can obtain up to 50% of the amount of your spouse's Social Security benefits; however, if you retire early, those benefits are reduced. .
Survivor benefits can be claimed when you're as young as 60, or 50 if you're disabled -- but claiming early will also cause a reduction in benefits. If both spouses have claimed benefits and one dies, survivor benefits are equal to whichever spouse's benefit was higher. They can be maximized by having a higher-earning spouse wait until age 70 to take Social Security, thus earning delayed retirement credits.
Because there are 81 different claiming strategies for married couples, there's a lot to consider when you're married. Talk to a financial adviser if you're not sure which approach is best.
Understanding Social Security is key to maximizing your income
Since Social Security will make up such a big part of your income, you owe it to yourself to understand how it works. Your income could be permanently impacted if you make a mistake, so get the advice you need and do the necessary research to avoid errors and maximize your benefits.