As of October, nearly 64 million people were bringing home a Social Security benefit check each month. Of these 64 million, more than four out of five are senior citizens, with approximately 62% counting on their monthly payout for at least half of their income.
Seniors' most important decision
It would be pretty fair to suggest that deciding when to begin taking Social Security benefits is the most important decision that seniors will make. That's because their claiming decision can have a big impact on what they'll be paid each month by Social Security, and may ultimately decide whether they can make ends meet during retirement.
As you may already know, there are more than a half-dozen factors that can impact what you'll receive from Social Security. Two of the best known are your work and earnings history. The Social Security Administration (SSA) will take your 35 highest-earning, inflation-adjusted years into account when calculating your monthly payout at full retirement age. This is why working into your 50s and 60s can be so important to boosting your overall benefit. By this age, you've probably built up experience and skills to command a higher annual wage or salary, which can aid in lifting your average monthly benefit. Mind you, the door swings both ways, with each year less of 35 being worked resulting in a $0 being averaged into your calculation.
Your birth year is another factor that tends to play a pretty important role in determining what you'll be paid. You see, your birth year determines your full retirement age -- i.e., the age at which you become eligible for 100% of your monthly payout. Claiming your retirement benefit at any point before hitting your full retirement age will result in a permanent reduction to that monthly payout. Likewise, taking your benefit after you hit your full retirement age will result in a boost above and beyond the full payout you're due. The full retirement age will peak at age 67 in 2022 for those born in 1960 or later.
And, of course, there's your claiming age. What makes this decision so hard is that there's no concrete guideline that everyone can follow as to when to take their payout. Everyone has different financial, marital, and health factors that matter to them, which makes their claiming decision unique.
But here's the thing about claiming age: It can make a big difference in what you'll receive each month. Beginning at age 62, your payout will grow by up to 8% annually for each year you hold off on taking your benefit. This continues until age 70. All factors being equal, such as work and earnings history and birth year, an individual taking their payout at age 70 can receive a monthly payout that's up to 76% larger than someone claiming as early as possible (age 62).
This is the biggest claiming mistake retirees can make
In some instances, it can beneficial for seniors to accept a permanent reduction to their monthly payout in order to begin receiving their benefit early. For example, someone in poor health who's unlikely to live into their 80s would probably collect more in lifetime income by taking their benefit early than by waiting an extra four to eight years to begin taking their payout.
The opposite can be true, too. Persons in excellent health who appear to have longevity on their side may be better served by waiting to take their Social Security payout and instead allowing it to grow over time. Assuming they live into their 80s, they'll have made a wise decision and increased their lifetime take-home from the Social Security program.
Even though there is no one-size-fits-all guideline when it comes to Social Security claiming strategy, there is one mistake that you'll definitely want to avoid. Arguably the single worst claiming decision that can be made is taking your benefit early if you have little or nothing saved for retirement.
There's no doubt that generating instant, guaranteed income from Social Security once you turn 62 can be tempting. However, if you have very little saved or nothing saved for retirement, this is a decision that could seriously come back to haunt you.
For one, claiming early means a guaranteed reduction to your monthly payout of up to 30%, depending on your birth year. This is a serious problem given that folks without adequate lifetime savings are liable to be reliant on Social Security as a major or sole source of income. If your only source of income is instantly reduced on a permanent basis by up to 30%, it's going to make your financial life difficult, to say the least.
Secondly, Social Security benefits are constantly being eroded by inflation. Even though Social Security passes along an annual cost-of-living adjustment that's designed to keep up with inflation, analyses show this "raise" rarely does its job, as intended. According to The Senior Citizens League, the purchasing power of Social Security dollars has fallen by 33% since 2000. This means already reduced payouts are able to buy even less over time.
Thirdly, filing for benefits early may expose you to the retirement earnings test. In simple terms, the retirement earnings test allows the SSA to withhold some or all of your benefits depending on whether your earnings cross certain thresholds. In other words, if you try to work and collect benefits in order to double dip on income streams, your plan could backfire.
Fourth and finally, there's the looming possibility of an across-the-board cut to retired worker benefits of up to 23% by 2035, based on the latest Social Security Board of Trustees report. The program is currently facing a $13.9 trillion cash shortfall between 2035 and 2093, and if Congress doesn't find a way to raise additional revenue and/or cut expenditures to close this funding gap, it's retired workers that'll pay the price.
Again, there are viable reasons to take Social Security early. However, having little or nothing saved for retirement isn't one of them.