Happy Halloween! Although Social Security may not be the scariest creature out there, talking about Social Security may make you want to run and hide. In this week’s post, we are taking a look at estimating your Social Security benefits. If you are like us and looking to retire early, we also explore how retiring early may affect your benefits.
Why can’t they make this simpler?
On Sept. 19, 2016, CNBC ran a story by Tom Anderson about how a study by the GAO recently revealed that the Social Security Administration (SSA) does a poor job of explaining retirement benefit options to applicants. Are we surprised?
The story struck a nerve with me because my mother applied for Social Security last year when she turned age 65. Leading up to her decision was a massive amount of confusion and misinformation. I sent my mother a book on how to maximize Social Security benefits to read more about it. She was getting a lot of bad information from her neighbors and friends. To complicate things, my step father was applying for disability benefits and there were a lot of factors for them to consider as a couple.
If you find Social Security to be incredibly confusing, you are not alone! What bothers me immensely about the study is even the Social Security employees aren’t doing a good job counseling us. They are supposed to be the subject matter experts!
There aren’t exactly mulligans in retirement. Providing down right false information is inexcusable with lifelong consequences for families. The SSA should distribute easy to understand guidance through multiple channels and help claimants figure out all options available to them.
Notice the very bottom of the ssa.gov website says “This website is produced and published at the U.S. taxpayer expense.” Really? Where’s the like and dislike button? I want to cast a vote. I guess FDR wasn’t thinking about web traffic and social media back in 1935, huh?
Where to Start?
Whenever pre-retirees ask me where to look for reliable information, I usually tell them to start brushing up by reading the AARP website. Since their main purpose is to serve retirees and pre-retirees, it’s an excellent starting place to read about government programs and what is and isn’t covered by the government. It helps you make sense of eligibility rules, the application process, and how things like working and taxes can affect your Social Security income. Check out the AARP Social Security page.
AARP does have an online Social Security benefits calculator. However, the tool is very basic because it only asks for your ‘average’ salary and does not take into consideration your actual earnings history. If your earnings history has been erratic like mine (due to being a stay at home mom for 5 years), then this will be highly inaccurate. What I do like is the simplified monthly payout chart that could look something like this sample:
After that pretty chart, they help you with a simple monthly expense budget to see how much of your needs will be met by the Social Security income at different ages. This may be helpful if Social Security will be a major source of income in your retirement plan.
But You Want the Real Numbers, Right?
Once you have a handle on the basics, it’s time to register for an online account at ssa.gov. You’ll need to follow the instructions and get your activation code. Once you have created your account, you can login and use the benefit planner tools to calculate your potential retirement income.
It’s also the place to go to verify that the SSA has correct earnings history for you. Seems important to make sure they know all the income you’ve had over the years to be sure you get all the benefits coming to you!
Early Retirees – They Got You Too!
The typical online retirement calculator assumes you continue to earn the same or similar (with a small annual merit adjustment) salary as you do today until you ‘retire’. Well, what about those of us who plan to stop working long before we start collecting Social Security benefits?
I was pleasantly surprised earlier this year when I tested out the online calculator at ssa.gov. It is possible to control your earnings history by essentially plunking in a goose-egg in those gap years between when you retire early and the earliest date you can collect Social Security. The AARP tool, for example, was not this robust.
We ran a few estimates on different retirement ages and assumed we would continue to both earn above the current Social Security Income tax cap only until an early retirement age of 52.
What we learned is that our planned early retirement age happens to coincide with the maximum number of earning years for Mrs. Need2Save (who left the workforce for a few years to be a stay at home mom). What that means is that at the time we stop working, it’s likely that both of us will have at least 35 years of earnings (Social Security takes your highest 35 years into consideration). Therefore, we will not need to keep working any longer to get our full benefits. There would be no zeros in our earning history even as early retirees, unless we stopped working even sooner than planned.
The advantage to continuing to work, however, would be to replace some of those low-earning years in high-school and college (part-time jobs). Assuming we stayed in our high-paying jobs, we could replace those low earning years with higher earnings years. However, only up to the maximum earnings subject to Social Security taxes! The maximum annual earnings subject to Social Security taxes was just raised to $127,200 for 2017. Earning above this amount yields no additional benefit (you also don’t pay taxes above that amount either – see our previous post on Social Security Tax Holiday).
If we decide to have earned income in our retirement years before we start collecting social security, those could also replace lower earning years in our profiles.
If your early retirement plans include leaving the work force at a very early age, note that you must work 10 years (40 credits) to be eligible for Social Security retirement benefits on your own record (not that of a spouse).
Using the Calculator on ssa.gov
So back to that SSA calculator. Below is a sample of what one of our estimates looked like. We assumed that we would continue to make at least the maximum earnings subject to Social Security taxes from now until the year we turn age 52. The difference between the first row of “at age 62” and the last row of “at age 62” is the first one assumes work stops at age 52 and the 2nd is if work continues until age 62 when benefits begin.
Obviously, there is almost a $300 difference between the 2 results. This is what would happen if earnings continue to be higher than earlier earning years and those are swapped out. But really? Only a $3,360 over the course of a whole year. That’s not very much and is not a huge motivation for us to keep working.
Clearly if you postpone filing for benefits until 67 (our full retirement age) or even the max age of 70, the amounts go up quite a bit. You should see this in your results no matter what your earning history has been due to the penalty applied if you take benefits prior to your full retirement age. A lot of folks think you need to work up until the time you are ready to collect Social Security. That is not the case for early retirees. You just should be sure your projections for future benefits take in to account the years when your earned income will be zero.
What Else Did We Learn?
Coincidentally, the difference in monthly benefit between Mr. Need2Save and Mrs. Need2Save at age 62 is only $235 a month or $2,820 annually. I point this out because we have a prior post about deciding if one parent can be a stay at home mom or dad for several years. This happens even though Mr. Need2Save will likely hit the annual cap 25 times vs. only 15 years for the Mrs.
Just for giggles, we also calculated how much in Social Security taxes we will have paid by the year we turn age 52. Assuming the next 9 years are flat (we know they won’t be but it’s just for illustration), Mr. Need2Save will have paid into the system over $175,000 and Mrs. Need2Save will have paid over $130,000. Wow that is over $300,000 just for our part. Our employers contributed the same amount, actually adding in a bit more than we did in 2011 and 2012 due to the payroll tax holiday.
If we both stopped working then at age 52, our combined benefit at age 62 (the earliest we could file) would be $3,325 a month or $39,900 a year. Setting aside whether we could have done better investing the money ourselves, we would get back what we paid into the system in under 8 years.
Remember this is taxable income. According to current rules for Married Filing Jointly, if we have other income from interest or dividends which push us over $44,000 when combined with 1/2 of our Social Security Benefits, this could subject up to 85% of our social security benefits to federal income taxes. Here’s where a strategy involving both pre-tax and post-tax retirement funds, say from a ROTH, are important to managing your taxable income in a given year. It’s also why, you may want to take some of your pre-tax 401(k) money out first before you start taking Social Security if you can keep the withdrawals to levels where you pay the lowest income tax possible. As many as 14 states tax Social Security benefits as well. Man, that $39,900 annual income is looking smaller and smaller. It’s a good thing we will have other investments to draw from.
Honestly, Mr. Need2Save and I are only in our 40’s right now so we have almost 20 years to decide and we are already debating pros and cons of what Social Security strategy to pursue. The truth is a lot can happen between now and then. With projected shortfalls, the federal government is going to need to make some changes – increase the annual maximum earnings that are subject to payroll taxes (which they did in a big way this year), increasing the standard retirement age, reducing benefits, etc.
Although we will continue to weigh our options and update our calculations periodically, we are also not depending on Social Security to be a major source of our retirement income. We don’t want to ignore it entirely either. Nor should you. It will simply be another bucket of money that we drain in our later retirement years.
It will most likely effect when we start drawing down our pre-tax retirement accounts. We could, for example, plan to reduce our withdrawals somewhat when we decide to start drawing one or both of our Social Security benefits. Or maybe we will suspend our pre-tax retirement withdrawals altogether for a while until we hit 70.5 when the mandatory required minimums will hit us.
So at the end of the day, maybe Social Security isn’t so scary after all.
Have you been to the SSA.GOV site and run your own projections? If so, how is it effecting your plans to retire early or when to collect your benefits?