Social Security is a vital source of income for many retirees. Your benefits from this entitlement program may be your only guaranteed source of lifetime income that's also protected against inflation.
Since your retirement benefits will definitely be there to help support you throughout your lifetime, you don't want to make major mistakes in deciding when to get your first payment. Unfortunately, many people are at risk of a huge error.
Are you one of them? Could this be the biggest mistake you make when it comes to claiming benefits?
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You can't afford to make this Social Security mistake
For many people, the most grave error they could make is not doing a break-even calculation before deciding what age to claim their retirement benefits. Sadly, many future retirees aren't even aware of what a break-even calculation is, let alone why it's so important to do one.
In simple terms, a break-even calculation is a calculation of how long it will take you to break even if you delay a claim for Social Security. But it's important to unpack that a little to know why this calculation is so essential.
See, you have the option to start Social Security checks at 62, although you also have a designated full retirement age based on your birth year. FRA is between 66 and six months and 67 for anyone born in 1957 or later. You also have the option of waiting to start Social Security until after your full retirement age.
Your choice about when to claim your benefits has a big financial impact. If you get your first payment at your exact FRA, you receive your "primary insurance amount." This is also called your standard benefit and it is equal to a percentage of the average amount of inflation-adjusted monthly income you made during your 35 best earning years.
When you start checks before your FRA, benefits shrink from this standard benefit. And when you start checks after your FRA, the standard benefit is increased. The reason that's the case is to try to equalize how much seniors get regardless of whether they claim Social Security benefits early or late. Early Social Security claimers get smaller checks but more payments over time, while late filers benefit from larger payments but miss out on years of Social Security income due to delaying.
A break-even calculation is important because it lets you know exactly how long it would take for you to make up for the missed years of benefits if you delayed a claim. If you don't expect to live longer than the time it takes to break even (and your spouse won't rely on survivor benefits), your best bet is to claim Social Security early. But if you think you'll have a long lifespan (or your spouse will rely on survivor benefits), you will be better off if you wait.
You can't make this determination until you do a break-even calculation. Don't make the huge mistake of forgoing this, because you could end up with much less lifetime Social Security benefits if you don't do this math.
How to do a break-even calculation
To do a break-even calculation, you need to know the amount of Social Security benefits you would receive each month if you claimed at different ages.
Say for example you're trying to decide whether to claim Social Security at 62 or 70. You'd want to know what amount you'd receive at each of those ages. You can find this out on your mySocialSecurity account, or by doing some simple math as follows:
- Find out what your standard benefit would be at your designated full retirement age.
- Apply early filing penalties or delayed retirement credits to that amount. Early filing penalties reduce your standard benefit by 5/9th of 1% for the first 36 months before FRA and by 5/12 of 1% for each prior month, while delayed retirement credits result in an increase of 2/3 of 1% monthly.
- Calculate how much income you'd miss out on during the years of delay, and calculate how much higher your future monthly benefit would be.
- Divide the years of missed income by the extra money that would come in each month to see how many months you'd need to receive the higher payments to break even.
An example can make understanding this simpler.
- Say you have a standard benefit of $1,500, a full retirement age of 67, and you are deciding between claiming benefits at 62 versus at 70.
- Apply early filing penalties to your $1,500 standard benefit. You'd be subject to a 30% benefits reduction if you claimed five years early at 62, so you would receive only $1,050 at that age.
- Apply delayed retirement credits to your $1,500 benefit. If you claimed at 70, you'd increase your benefit by 24%, so you would get a standard benefit of $1,860.
- Delaying from 62 to 70 would mean missing eight years of monthly benefits totaling $1,050. So the delay would cost you $100,800. You would receive $810 extra in each monthly check once you claimed, though.
- Divide $100,800 by $810 to determine you'd break even after 124.4 months.
By doing this calculation, you would see that you'd need to live about 10.4 years beyond age 70 to break even. Armed with this info, you could decide whether claiming at 70 really is likely to pay off, or whether an early claim is best.
Not taking the time to do a break-even calculation, though, would leave you without vital information needed to decide on your Social Security claiming strategy. So don't make that huge mistake. Do your math before you file for your Social Security benefits to begin or you could leave a lot of money on the table.
