Whether you realize it now or not, there's a very good chance that you're going to be reliant on Social Security income when you retire. According to annual polls conducted by Gallup, 90% of current retirees lean on Social Security as a major or minor source of income. Meanwhile, 83% of pre-retirees expect to count on Social Security as a major or minor income source during their senior years.
Both of these percentages are at, or very near, all-time highs, which at the very least suggests the importance of making an educated claiming decision to maximize what you'll receive from Social Security. However, data suggests that most retired workers are making a very big mistake with regard to their Social Security claiming age.
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A better understanding of how your Social Security benefit is determined
Before diving into this potentially monumental mistake, let me provide some color on the most important factors that go into determining your eventual payout from the Social Security program, assuming you've earned the 40 lifetime work credits to receive a retired worker benefit.
The first two -- your work history and earnings history -- are linked at the hip. The Social Security Administration (SSA) will take your 35 highest-earning, inflation-adjusted years into account when calculating your benefit at full retirement age. Not only are you incented to earn as much as you can in the years you do work, but for every year less of 35 worked, a $0 will be averaged in its place.
A third factor that plays a big role is your full retirement age. This is the age at which you are eligible to receive your full monthly retired worker benefit, as determined by your birth year. Pretty much everyone has a full retirement age of 66 or 67, or in rarer cases, somewhere in between. The general rule is that your payout will be permanently reduced if you begin taking it prior to reaching your full retirement age. Conversely, it can also be higher than what you'd receive at full retirement age if you continue waiting and claim it later.
That brings up the fourth and, arguably, most important factor: your claiming age. Although benefits can begin as early as age 62 for eligible seniors, the program incentivizes patience. For every year you hold off on taking your payout, it'll grow by as much as 8%, up until age 70. If we were to place two retired workers with identical scenarios next to each other (i.e., same work history, earnings history, and birth year), the one claiming their benefit at age 70 could earn as much as 76% more per month than a retired worker taking their payout as soon as possible (age 62).
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The biggest mistake eligible beneficiaries could make
You'd think the allure a larger monthly payout would encourage retirees to hold off for a while and allow their eventual payout to grow in value. However, this often proves not to be the case, with the SSA noting that around 60% of retired workers take their payout prior to reaching age 65. Comparatively, only around 10% of claimants begin taking their Social Security retirement benefit between ages 67 and 70.
Why are so many retirees taking their benefit early? It looks to be a combination of being uninformed or wrongly informed about their choices, as well as the prevailing (but wrong) belief that the Social Security program won't be there when they retire, or much longer after they retire. Although the Social Security Board of Trustees has cautioned that the program has insufficient revenue over the next 75 years to cover expenditures, bankruptcy isn't a possibility. But, to be clear, this doesn't rule out the potential for a substantial cut to benefits in the future.
Unfortunately, for most retired workers, this decision to begin receiving their payout well before their full retirement age is a big mistake.
This past June, United Income released a report, "The Retirement Solution Hiding in Plain Sight," that examined the claiming decisions of seniors in roughly 2,000 households. Researchers then compared the claiming decisions of these folks to what would have been optimal given their life expectancy and/or financial needs. By "optimal," researchers meant the age that would have resulted in the highest lifetime payout, not necessarily the highest monthly payout.
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As you might expect, most seniors failed to optimize their take-home pay from Social Security, which is a function of (thankfully) not knowing our own expiration date. But what really stood out was the complete bifurcation between actual claiming ages and optimal claiming ages. United Income found that 57% of all seniors in its study would have received the most money from Social Security if they waited until age 70 to begin taking their payout. Today, only around 1 in 25 seniors actually wait until age 70 to take their payout.
What's more, over 80% of retired workers would have optimized their lifetime benefit by waiting until at least age 67 to begin taking their payout.
By comparison, claiming their benefit prior to age 64 would have been optimal for a meager 6.5% of seniors.
While there are valid reasons for some folks to claim their benefit early, such as being in poor health, the data overwhelmingly suggests that the biggest mistake eligible retired workers can make is taking their benefit early. Though claiming late doesn't guarantee you'll see a larger payout, it does give you the best odds of maximizing what you'll receive from Social Security over your lifetime.
