1 Common Social Security Mistake Could Cost Retirees $182,000

The Social Security program cuts a monthly check to millions of Americans, and those benefits are often the largest source of income in retirement. In fact, nearly 9 in 10 retired workers depend on Social Security benefits to some degree, according to pollster Gallup. But many Americans misunderstand certain aspects of the program, and knowledge gaps can lead to costly mistakes in retirement.

One common misconception relates to the reduced benefit paid to workers who collect Social Security before full retirement age (FRA). Nearly half of adults believe the reduction is temporary, thinking their benefit will automatically increase when they reach FRA, according to Nationwide Retirement Institute. But the reduction is permanent, and workers who claim benefits prior to FRA could pay a high price for that decision.

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How age impacts Social Security benefits

Workers' Social Security benefits are calculated based on the earnings from the 35 highest-paid years of their careers. Those earnings are indexed (i.e. adjusted for wage inflation) and averaged, then run through a formula to determine the primary insurance amount (PIA), which is the benefit a worker would receive at FRA.

Workers are eligible for retirement benefits at age 62, but claiming Social Security prior to FRA results in a reduced benefit, and the reduction is permanent. That is worth repeating: Workers receive permanently reduced benefits if they collect Social Security before their FRA. The extent of the reduction depends on how many months early the payouts begin, but it can be as much as 30% of the PIA.

The chart below details FRA based on birth year, and it shows the benefit reduction each cohort would incur if they started Social Security at age 62.

Source: The Social Security Administration.

Workers that delay retirement benefits beyond FRA receive a credit of 8% per year. That means a person born in 1960 who claims Social Security at age 70 will receive an extra 24% in retirement benefits, or 124% of their PIA. The credits stop accumulating at age 70, so it never makes sense to wait any longer.

Most workers should delay retirement benefits until age 70

In 2021, more than half of newly awarded retirees claimed Social Security benefits before reaching FRA, and one-quarter of newly awarded retirees claimed benefits at age 62. That decision comes with a big price tag for most people. Of course, there are situations in which it makes sense to start benefits early, but 90% of workers aged 45 to 62 would come out ahead by delaying Social Security until age 70, according to a study from the National Bureau of Economic Research (NBER).

However, the NBER says only 6% of people are likely to wait that long, resulting in a median loss in lifetime discretionary spending of $182,370 for workers aged 45 to 62. In other words, delaying benefits until age 70 would boost the discretionary spending of the median worker in that age cohort by $182,370 over their lifetime. That figure accounts for lifespan uncertainty, as well as federal and state tax programs.

As a caveat, delaying Social Security results in temporary cash flow constraints for many workers, so the decision is not black and white. Workers must decide whether a lower standard of living in the short term is worth more spending power in the long run. There is no right or wrong answer. But anyone who makes the decision without first understanding the facts could make a very costly mistake.