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The most popular age for starting Social Security retirement benefits is 62, the earliest age allowed. In fact, 90% of workers claim benefits at or before their full retirement age. If you're getting ready to file for Social Security benefits -- especially if you're doing it early -- here's what you need to know about one of the most important financial decisions you'll ever make.

How your Social Security benefit is calculated
Unlike many pension plans and other fixed-benefit retirement systems, Social Security isn't just based on the last few years of a worker's earnings. Rather, Social Security takes the 35 highest years of inflation-indexed earnings into account when determining your benefit.

Each year's earnings are multiplied by a factor to adjust for inflation. You can see the full list here (link opens PDF), but just to name a few, your earnings from 2010 are multiplied by 1.12, 2000 earnings are multiplied by 1.45, and 1990 earnings are multiplied by 2.21 (keep in mind that the multipliers change each year). Each year had a maximum amount of earnings subject to Social Security taxes -- $118,500 currently -- so there is an upper ceiling to how much can count from each year.

Once this is done for all of your working years, the top 35 are averaged and divided by 12 to come up with your lifetime monthly average Social Security earnings. This monthly amount is then plugged into the following formula:

  • 90% of the first $856
  • 32% of the amount between $856 and $5,157
  • 15% of the amount above $5,157

For example, let's say that after adjusting your earnings for inflation, the monthly average of your 35 top years is $3,000. Applying it to this formula produces a monthly benefit of $1,703.

The effect of early or late retirement
Your full, or normal retirement age depends on the year you were born. For those reaching retirement now, normal retirement age is 66. Starting with workers born in 1954, the retirement age will increase by two months each year until it reaches 67 years old for those born in 1960 or later.

Choosing to start Social Security benefits before or after normal retirement age can reduce or increase your monthly benefit amount. Early Social Security reduces your benefit by 6-2/3% per year for up to 36 months before normal retirement age, and by 5% per year beyond that.

Conversely, delayed retirement increases your monthly benefit amount by 8% per year, and these delayed retirement credits can accumulate until as late as age 70. In other words, someone who waits as long as possible to start collecting Social Security would permanently increase their benefit by 32%. Here's a guide to help determine the effect of early or late retirement on your Social Security income:

If You File for Social Security at This Age...

Your Benefit Will Be (Percentage of Primary Insurance Amount)

Effect on a $1,500 Monthly Benefit




























Note: This is for retirees born before 1954. For later retirement ages, the same percentages apply, but the ages will be slightly greater, depending on birth year. Data source: SSA.

The double-benefit of working more
I mentioned earlier how Social Security takes your 35 highest-earning years into account when determining your monthly benefit.

For most people, salary doesn't just keep up with inflation over the course of a career, but it increases on an absolute basis as well due to promotions, job changes, etc. In other words, the later years of a career are typically the highest-paid years.

Let's say that your best 35 years of earnings range from $30,000 to $65,000 on an inflation-indexed basis, and your lifetime average is $47,500. To keep things simple, we'll say that your earnings increased at a steady $1,000 per year throughout your career. If you work for another two years and earn $66,000 and $67,000, those two years will now factor into the benefit formula and your lowest two years (let's say $30,000 and $31,000) will no longer play any role. All of a sudden, your lifetime average has increased to $49,500. In other words, not only will you get delayed retirement credit for waiting two years, as I described earlier, but your calculated primary insurance amount is now based on a higher lifetime average – so, you get a permanent increase in two different ways.

As a personal example, my Social Security statement shows 18 years of work experience so far, but two of those were when I was working at Burger King during high school and earning about $5,000 per year. Once I get a total of 37 years of work under my belt, those two are no longer factored into the calculation and will no longer be dragging down my lifetime average.

Chances are that by choosing to remain in the workforce a year or two longer, you could have a similar effect on your own Social Security benefit calculation. What were your 34th and 35th lowest years? Wouldn't it be nice if they weren't dragging down your average anymore?

What should you do? It depends
If you have sufficient savings, or you're sure that claiming Social Security early will provide you with the financial security you need, go for it. However, it's important to be aware of how your benefit is calculated, as well as the potential effects of holding off for a year or two.