When you retire, there's a very good chance that your Social Security income will become vital to making ends meet. Social Security Administration data shows that 62% of current aged beneficiaries lean on their monthly check to comprise at least half of their income. And while future retirees expect to be less reliant on the program, some 84% still intend to lean on Social Security in some capacity during retirement, according to an April 2018 Gallup survey.

With that being said, there's perhaps no decision that's more important to qualifying senior citizens than deciding when to claim their Social Security benefit. For those unfamiliar, benefits can begin at age 62, or at any point thereafter.

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If you claim benefits early, Social Security can penalize you three ways

Data culled from the Center for Retirement Research at Boston College finds that roughly 45% of claimants take their entitlement at age 62, with approximately 60% claiming between ages 62 and 64. Beyond these early claimants, close to 30% take benefits at either age 65 or 66, while the remaining roughly 10% take benefits between ages 67 and 70.

Though there are plenty of valid reasons for claiming Social Security benefits early, there are also three penalties that you should be aware of if you do so.

1. A permanently reduced monthly payout

The most front-and-center penalty for claiming benefits early -- let's define "early" as any point prior to your full retirement age -- is that it'll permanently reduce your monthly benefit.

As noted, benefits can begin at age 62. There is, however, a pretty big incentive to wait to begin taking your entitlement. For each year an individual waits to take their benefit, it increases by approximately 8%, up until age 70. Assuming we were looking at two identical individuals with the same income and work history, as well as birth year, the one claiming at age 70 could net up to 76% more per month than the one claiming at age 62.

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Based on your full retirement age -- the age at which you'll receive 100% of your retirement benefit, as determined by your birth year -- this means claiming early can reduce your monthly take-home by as much as 25% to 30%, depending on your birth year.

For example, the Social Security Administration (SSA) notes that the average retired worker brought home $1,414.73 in July 2018. If an individual turning 62 in 2018 claims their payout as soon as possible, they would see a permanent reduction of 26.7% relative to what would have been their full retirement age benefit. Assuming this was the average retired worker, we're talking about a monthly payout of $1,037, or $12,444 a year. That's more than a $4,500 annual reduction from what a person born in 1956 would receive if they'd waited to take their entitlement at their full retirement age of 66 years and four months. 

Although waiting doesn't work for everyone, those claiming early need to understand the consequences of doing so.

2. A potentially reduced or withheld payout via the retirement earnings test

A second way your Social Security benefit could take a hit when claiming early is by being exposed to the retirement earnings test.

In its simplest form, the retirement earnings test allows the Social Security Administration to withhold some, or all, of your retired worker benefit if your income exceeds a certain level. Please note that the retirement earnings test applies only to workers claiming benefits prior to their full retirement age (also known as "normal retirement age" by the SSA). If you've claimed early and reached or surpassed your full retirement age, or simply waited until later to claim benefits, then the retirement earnings test has no bearing on you.

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If an individual won't reach their full retirement age in 2018, $1 in benefits will be withheld for every $2 in earnings above $17,040. Thus, an individual who wishes to continue working but also claim benefits at age 62 may not be able to double dip and receive both sources of income. If you earn too much, the SSA may just withhold some, or all, of your benefit.

For individuals who will be hitting their full retirement age in 2018 but have yet to do so, the SSA can withhold $1 in benefits for every $3 in earnings above $45,360.

If there is a silver lining here, it's not as if the withheld benefits are forfeited or lost forever. You'll get them back once you hit your full retirement age in the form of a higher monthly payout. 

3. A reduced survivor benefit for your loved ones

Lastly, early claimants can be indirectly hurt since their enrollment could impact the earning potential of their loved ones.

If you're single and have no young children, then your claiming decision really is all about you. But if you have a wife or husband and/or school-age children, then your claiming decision becomes a little more complicated -- especially if you're the income breadwinner of the household.

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You see, if you happen to pass away prior to your spouse, the survivor benefit that your spouse may receive as a result of your earning and work history could be reduced if you claimed benefits prior to reaching your full retirement age. The SSA bases the surviving recipients' payout on what the deceased worker was receiving each month. Or in simpler terms, claiming early could mean putting your loved ones on shakier financial footing after you're gone.  

To reiterate, claiming early does make sense for some retired workers. But if you're going to take your benefit before reaching your full retirement age, you need to fully understand the consequences.

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