It's arguably the hardest decision senior citizens will ever make: deciding when to begin taking their Social Security benefits.
According to the Social Security Administration (SSA), 62% of today's retired workers generate at least half of their monthly income from the program, meaning a poor claiming choice could wind up costing them a lot of money. Unfortunately, there aren't any concrete guidelines or one-size-fits-all tactics when it comes to taking your Social Security benefit, which makes the decision a combination of science and luck.
Most retired workers claim benefits early, but it can be a mistake
What we do know is that far more seniors choose to claim their retirement benefit earlier than later. Approximately 60% of all retired workers begin taking their Social Security payouts between ages 62, the earliest age possible to commence benefits, and 64. Meanwhile, just 1 in 10 workers waits until between ages 67 and 70 to begin taking a payout from the program.
To be clear, claiming Social Security early may offer advantages for certain retirees. If, for example, a retired worker was in poor health or had a chronic health condition, they may not live to the average life expectancy in the U.S. of 78.6 years. In this instance, taking their benefit early would allow for a greater probability of collecting a larger lifetime benefit (note the emphasis on the word "lifetime").
Another example where taking benefits early would make sense is if you have no other sources of income or limited earning capacity. While being forced into taking benefits for lack of employment is less than ideal, it's a valid reason for claiming benefits at an early age.
However, taking your Social Security benefit early -- i.e., before reaching your full retirement age -- can also backfire.
1. Claiming early permanently reduces your monthly take-home check
The most immediate drawback to taking your benefit early is that you'll be accepting a permanent reduction to your monthly payout of up to 30%, depending on your birth year. That's because the Social Security Administration actually incents retirees to wait to take their benefits.
For each year you hold off on taking your payout, it grows by approximately 8%, up until age 70. All things being equal (e.g., work history, earnings history, and birth year), an individual claiming at age 70 can earn up to 76% more per month than a person taking their payout as early as possible (age 62).
For some people, this early claim and permanent monthly payout reduction still makes sense, as it helps them to maximize what they'll receive from Social Security over their lifetimes. However, a study from United Income that was published in June showed that early claims are rarely optimal. In hindsight, just 6.5% of claimants between the ages of 62 and 64 made the optimal decision.
Furthermore, if you live to the average U.S. life expectancy age or beyond it, you will have given up a substantial amount of lifetime benefits by claiming early at a reduced rate.
2. It can hurt the financial earning potential of your spouse
Claiming Social Security benefits early can also backfire if you're married.
If you're single and have no young children, then your decision as to when to begin taking Social Security benefits really is all about you. But if you're married, this claiming decision can require a lot of additional thought.
As an example, if you should pass away before your spouse, he or she would have an opportunity to begin receiving a survivor benefit based on your earnings history, assuming that benefit was higher than what they would receive based on their own work and earnings history. If you wait until your full retirement age to begin taking your payout, your spouse has the option of maximizing their survivor benefit.
However, if you begin taking your benefit early, your surviving spouse may pay the price with a reduced survivor payout. This can be especially problematic if you were the income breadwinner of the household and took your benefit early.
3. It'll potentially expose you to the retirement earnings test
An early Social Security claim can also come back to haunt seniors who work while receiving benefits. That's because all beneficiaries who've not yet reached their full retirement age may be subjected to the retirement earnings test.
Put simply, the retirement earnings test allows the SSA to withhold some or all of a worker's benefits based on their income if they're not yet at full retirement age. If, for instance, a beneficiary in 2020 won't reach their full retirement age in 2020, the SSA can withhold $1 in benefits for every $2 in earned income above $18,240 (that's $1,520 a month). Earning less than this amount would not trigger any benefit withholding.
Meanwhile, if you will reach your full retirement age sometime in 2020, you'll be allowed to earn up to $48,600 ($4,050 a month) next year before withholding kicks in. For every $3 in earned income above $48,600 next year (prior to reaching your full retirement age), the SSA will withhold $1 in benefits.
The silver lining here is that early claimants who have their benefits partially or fully withheld do get this money back in the form of a higher monthly payout after hitting their full retirement age. But the downside is that double-dipping working wages with a Social Security benefit prior to reaching your full retirement age may not work.