You may be eager to start collecting Social Security benefits as soon as you become eligible at 62. But following the most common path among retirees could leave you wanting more later in life.
Despite being the most common age of new applicants, 62 is usually a sub-optimal decision for retirees hoping to maximize all of their assets in retirement to live their best life in their golden years. Not only will you see a reduced monthly benefit, you'll also face challenges when it comes to tax planning. And if you're working while collecting Social Security, you could see your benefit reduced even more.
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A big cut in your monthly benefit
When you decide to claim Social Security, your monthly benefit is calculated based on three factors: Your Primary Insurance Amount, your full retirement age, and the age when you apply.
Your Primary Insurance Amount, or PIA, is based on your historical earnings. The Social Security Administration adjusts your annual earnings for inflation and calculates the average of your 35 highest-earning years. It then plugs those earnings into the Social Security benefits formula to determine your PIA.
Your full retirement age (FRA) is dependent on when you were born. Anyone born in 1960 or later currently has an FRA of 67. Those born between 1955 and 1959 have an FRA between 66 and 67. Those born earlier have an FRA of 66. If you claim Social Security at your FRA, you'll receive your Primary Insurance Amount.
When you claim, relative to your FRA, makes a big difference. Claim early and you'll reduce your benefit. Claim later, and you'll receive delayed retirement credits, increasing your benefit.
Those with an FRA of 67 who apply as soon as they're eligible at 62 will only receive 70% of their Primary Insurance Amount.
That's a massive cut in benefits. And while you'll collect your Social Security checks for a longer period of time, most retirees don't end up collecting more from Social Security by claiming early. Fewer than 10% of retirees will maximize their lifetime benefit by claiming Social Security before 65, according to a 2019 study from United Income.
Paying a bigger tax bill on a smaller check
On top of a lower monthly benefit, claiming early can also negatively affect your personal retirement savings. That's because you could potentially end up paying more in taxes on your retirement account withdrawals, Roth conversions, and capital gains when you also have to factor in the effect of Social Security.
The IRS taxes Social Security benefits based on a metric called "combined income." Combined income is the sum of your adjusted gross income, nontaxable interest income, and half your Social Security benefits. If your combined income exceeds a certain threshold, a portion of your Social Security benefits becomes taxable.
| Taxable Amount | Combined Income Range (Single) | Combined Income Range (Joint) |
|---|---|---|
| 0% | <$25,000 | <$32,000 |
| Up to 50% | $25,000 to $34,000 | $32,000 to $44,000 |
| Up to 85% | >$34,000 | >$44,000 |
Table source: Author. Data source: Social Security Administration.
This mechanism can result in a sort of double taxation on retirement account withdrawals or capital gains if it pushes you over one of those thresholds, because you'll end up paying taxes on the withdrawal and making more of your Social Security benefits taxable. That's known as the Social Security tax torpedo.
It's easier to deal with the tax torpedo by planning ahead and giving yourself time to position your retirement portfolio to minimize taxes' effect in the future. The best time to do that is in the first few years of retirement before collecting Social Security.
It gets even worse if you're still working
If you're working while collecting Social Security, which isn't uncommon at age 62, you could see a much smaller Social Security check than you expected.
Workers under their FRA who are actively collecting Social Security are subject to the earnings test. Those under FRA for the full year will see $1 deducted from their benefit payments for every $2 earned above an annual earnings limit. For 2023, that limit is $21,240. So, you could see a big portion of your Social Security benefit wiped out even with just a modest income.
It's important to note that you'll start receiving any amount deducted from your benefits payments once you reach FRA. The Social Security Administration will recalculate your benefit as if you delayed retirement beyond 62, based on how much was withheld through the earnings test.
Claiming at 62 isn't the best option for most retirees. If you want to make the most of your retirement savings, it behooves you to find a way to delay applying for benefits at least a little bit longer.
