You don't want to make mistakes today that will hurt your retirement down the road. One path to financial success is putting yourself in position to get the largest possible Social Security checks in retirement. Not everyone can make a change today that will affect future retirement benefits, but it's important to prepare the right way so that you can make the proper adjustments when the time comes.
1. Maximize the income used in benefits calculation
Social Security benefits are calculated based on something called average indexed monthly earnings (AIME). This is basically the average monthly income that you earned over your 35 most lucrative years paying into the Social Security system, adjusted for changes in the standard of living over that time frame.
In general, most people can't simply choose to make more money. However, understanding the method used for calculating benefits could help to guide important employment decisions for some people who are concerned about their monthly Social Security checks.
Image source: Getty Images
For example, if you're employed part-time, you may want to explore full-time positions or find complementary part-time engagements. Other people who might not have a full 35 years of earnings might choose to return to the workforce in an effort to erase some of the zero-earnings years from their AIME. Those considering retirement near the height of their earning power might elect to replace some of their lower-income years by extending their careers to increase AIME. If you fit in one of these groups, then you can make a decision today that will increase your benefits down the road.
Self-employed workers may also consider the impacts of their deductions that reduce taxable income. Tax accountants will often work with their clients to identify all of the possible expenses and deductions to minimize their tax bill. That's usually the best move for financial planning in general, but it won't necessarily help those most concerned with their retirement benefits. The Social Security wage cap is set to rise to $168,000 next year. In some rare cases, it might make sense to defer deductions or schedule certain expenses to maximize AIME if it doesn't meaningfully change your tax bill over the course of a few years.
2. Prepare to take benefits at a later age
People can start receiving benefits as early as 62 or as late as 70. The later you elect to turn on the Social Security income faucet, the larger the monthly check will be.
Obviously, this is only something that you can change today if you're actively deciding on the age to start taking benefits. Those eligible to receive Social Security income can increase their monthly income by waiting. Full retirement age (FRA) is 67 for people in that position right now, and your monthly check can grow by roughly 25% if you wait until age 70 to start drawing payments.
Even if you're not in position to make the choice today, you can adjust your retirement plan to accommodate delayed benefits in the future. You don't have to commit to anything, but it can be helpful to set goals and expectations accordingly. People who want to take Social Security as late as possible might accumulate more assets in their retirement accounts by spending a few more years working or increasing their savings rate.
This point also applies to spousal benefits. Taking that income before FRA can reduce the monthly payout by up to 35%, so couples need to keep this in mind when preparing for future decisions.
3. Stop working if you're taking benefits before FRA
If you're under FRA and receiving Social Security benefits, you might be subject to reduced payments. People who won't attain FRA this year and earn at least $21,240 annually will have their Social Security benefit reduced. That reduction is equal to $1 for $2 in earnings above the limit. This reduction can be significant for anyone who's employed full-time. The limit doesn't apply to income from pensions, investments, and annuities, so making adjustments to those cash flows won't increase your benefit.
From a strictly financial standpoint, you're better off with each extra dollar of income, even with the reduction. Moreover, after you reach full retirement age, the Social Security Administration adjusts your benefits to account for the amount of the reduction. However, people need to consider the net increase from every marginal dollar of income. If you hit the income limit in a certain year, it might make sense to stop working for a while to keep benefits maximized throughout the rest of the year.
4. Minimize taxes on your benefits
For the 2023 tax year, there are 12 states that tax Social Security benefits in some way. This shouldn't be the only factor for picking a retirement state, but it's a factor to consider if you want to maximize net cash flow available to meet your retirement needs.
Households that intend to make significant withdrawals from retirement accounts can also set up a more tax-efficient strategy to reduce the federal tax liability on Social Security. A portion of benefits are subject to federal income taxation for households that exceed certain income limits. It might make sense to structure account distributions in a manner that minimizes taxable income during the years when Social Security is claimed. For example, you might save into accounts so that you can use 401(k) distributions, dividends, and interest to fund the early years of your retirement. Then you can supplement Social Security with Roth distributions or non-qualified assets after age 70.
The specifics vary from case to case, but setting up the right savings plan today could transform your tax liabilities in retirement.
