For more than 80 years, Social Security has been providing a financial foundation for retired workers. Data from the Social Security Administration finds that 62% of all current retirees rely on the program for at least half of their monthly income, with 34% leaning on Social Security for virtually all (90% or more) of their income.
What's more, an analysis from the Center on Budget and Policy Priorities found that the elderly poverty rate would be over 40% if Social Security didn't exist. That compares to an elderly poverty rate with Social Security of less than 9%.
Most retired workers take their Social Security benefit early
Suffice it to say, Social Security plays a critical role in helping seniors make ends meet. This means a worker's claiming age (i.e., the age when they begin taking their Social Security retirement benefit) can significantly affect what they'll receive each month and over their lifetime.
The big question for retirees is when they should take benefits.
The simple answer is that there is no simple answer. Since we thankfully don't know our own expiration date, we can never know for certain if we've made an optimal claiming choice. By optimal, I'm referring to the choice that maximizes what you'll receive from Social Security over your lifetime.
However, the data is pretty clear that the majority of currently retired workers have preferred to claim Social Security early -- i.e., before their full retirement age, which for most current retirees would be anywhere from age 62 through age 65 and 11 months.
But is claiming Social Security early a smart move? Let's take a look at three key pros and cons of filing for benefits prior to hitting your full retirement age.
Three advantages of filing early for Social Security
1. You'll be healthy or young enough to enjoy your extra income
Perhaps the most obvious positive of taking your Social Security benefits early is the ability to enjoy your added income while you're still relatively young and healthy. Although waiting to take your benefit can increase your monthly payout by up to 8% per year, beginning at age 62 and ending at age 70, there's no guarantee that your health will hold up long enough to enjoy your added income. Claiming benefits early could allow you to generate extra income to take vacations or fund hobbies.
2. It'll allow your existing investments time to grow
A second potential advantage of taking your Social Security benefit early is that it could give your nest egg time to continue growing. According to national pollster Gallup, 55% of Americans own stocks, with the 50-to-64 crowd having the highest percentage of stock ownership (66%) among all of the age groups surveyed. If these investors feel confident enough that they can outpace the up to 8% annual return they'd receive by holding off a year on taking their Social Security payout, then an early claim might be worthwhile. Interestingly, the broad-based S&P 500 has averaged an annual return of 13.6% over the past 10 years, inclusive of dividends paid.
3. You'll minimize the loss of Social Security income purchasing power
A third and final advantage to an early claim is the ability to minimize the loss of purchasing power associated with Social Security income. According to a report from The Senior Citizens League, the purchasing power of Social Security income has declined by 30% since 2000. That's because the program's inflationary tether, the Consumer Price Index for Urban Wage Earners and Clerical Workers, does a poor job of tracking the real costs seniors are facing. Generally speaking, the longer seniors wait to take their payout, the more exposed they become to this Social Security income erosion, relative to inflation. An early claim would mitigate somewhat this decline in purchasing power.
Three disadvantages of taking Social Security early
Of course, there are two sides to every Social Security claiming decision. Here are the cons of taking your retirement benefit early.
1. Your payout could be permanently reduced by up to 30%
The most obvious disadvantage of taking your Social Security benefit prior to reaching full retirement age is that you'll be accepting a permanent reduction to your monthly payout. Depending on your birth year, taking your payout as soon as possible (age 62) could result in anywhere from a 25% to 30% reduction from what you would have received had you waited until your full retirement age (often age 66, 67, or somewhere in between). If you happen to live into your 80s, this early claiming decision often means leaving substantial amounts of lifetime benefits on the table.
2. The SSA may be able to withhold some or all of your benefits
Another problem with taking Social Security benefits prior to reaching full retirement age is that you'll be exposed to the retirement earnings test. This "test" allows the Social Security Administration (SSA) to withhold some or all of your benefits if you earn too much.
For example, if you've taken your payout early and you won't hit your full retirement age in 2020, the SSA can withhold $1 in benefits for every $2 in earned income above $18,240 ($1,520 a month). That's not a lot of income before withholding kicks in, which means dreams of double-dipping with work income and Social Security may be shattered for some early filers.
For folks who will hit their full retirement age in 2020, but have yet to do so, the SSA can withhold $1 in benefits for every $3 in earned income above $48,600 ($4,050 month).
3. You may be financially sabotaging your loved ones
Finally, an early claim could adversely impact the earning potential of a surviving spouse. This can be especially important if the income breadwinner of the household is the one who passes away first. The SSA bases survivor benefits on what a deceased worker was netting each month. If that worker chose to file for benefits early, the payout available to the surviving spouse would be reduced. In other words, it can pay to wait if it means ensuring the financial livelihood of your loved ones.
Is claiming early a smart move? That's up to you to decide.