Making a choice about when to retire can impact your finances in profound ways — especially if you'll be claiming Social Security upon leaving the workforce.
See, your age when you get your first retirement check could result in a big reduction — or a big increase — from your standard benefit. And retiring even a year earlier could leave you with far less money over the course of your lifetime if you start Social Security upon departing from your job.
Just how much could getting benefits early impact your monthly and lifetime income? Here's what you need to know.
You'd be surprised how much of a difference a year makes when it comes to Social Security
The amount of your Social Security benefit is based on two primary factors:
How much your inflation-adjusted average wages are during your 35 highest-earning years
When you claim your benefit relative to your full retirement age
Both of these factors can be affected by retiring and claiming benefits even a year early. Here's how.
Retiring a year early can reduce your average wage
If you don't work for a full 35 years, you'll take a hit to your benefit because Social Security still uses this timeframe to calculate your career-average wage. And benefits are based on a percentage of these average earnings.
Retiring a year sooner makes it more likely you won't have a 35-year career history and will have at least a year of $0 wages included. And this can substantially reduce the benefits you get. Say, for example, you were born in November of 1956, started working in 1986, earned a salary of $19,000, and bumped up your earnings by 2% each year. If you worked for a full 35 years, your benefit at full retirement age would be $1,775. But if you worked for just 34 years and were one year short, it would come down to $1,743.
You'd miss out on $32 per month or $384 per year in this case — not only because of the inclusion of a year of $0 wages, but because you'd miss out on that last year when your salary would've been a little bit higher due to your annual raise. This illustrates another issue with retiring a year earlier. Even if you already have 35 years in, chances are good your salary goes up over time. If that's the case, each extra year of work you put in can prevent a lower-earning year from being included when average wages are calculated.
The exact impact of not putting in some extra time to avoid low-earning years counting in your benefits formula depends on just how big the discrepancy is between what you're earning now and how much money you made earlier in your career.
Unfortunately, you'll face this consequence even if you retire without actually claiming Social Security benefits, since you'll be giving up the chance to increase the higher career-average earnings benefits are based on.
Retiring a year early could also mean more early filing penalties or missing out on delayed retirement credits
If you must claim Social Security to retire — as many people do — then leaving the workforce earlier than planned can impact your benefits in other ways as well. This could happen because you either get hit with more early filing penalties that reduce the standard benefit you're entitled to, or because you miss out on the chance to earn delayed retirement credits that increase that benefit.
The financial impact of retiring a year earlier depends on exactly when you retire, relative to something called your full retirement age. Your FRA is between 66 years and 4 months and 67 years, depending on your birth year. You must claim your first Social Security check at exactly that age to get the standard benefit you're owed based on career-average wages.
Early filing penalties and delayed retirement credits both apply monthly, and the penalties or benefit boost adds up a lot over the course of a year. In fact:
For each of the first three years you retire before full retirement age, you face a 6.7% annual reduction in your standard benefit.
For each prior year you claim early beyond the first three years, you face an additional 5% benefit cut.
For each year of delay after full retirement age until 70, you can get an 8% benefit increase.
So, if your full retirement age is 66 and four months and you claim benefits at 65 and four months, you'd end up shrinking monthly benefits by 6.7%. If we take our example above, your $1,743 benefit would be further reduced by 6.7%, bringing it down to $1,626. That's a full $149 less per month than the amount that would've been available if you'd put in an extra year of work and not seen your checks shrink due to early filing penalties or being a year short of 35 years.
And even if you wait until full retirement age, you'll still be shrinking the potential checks you could've obtained for each year you retire early. So, unless you wait until 70, retiring and getting your first Social Security check is always going to leave you with less monthly income than you could have had.
Now, some people will decide it makes sense to start payments earlier because delaying means missing out on current income in exchange for a higher future benefit later. But be aware that the decision you make affects monthly payments for the rest of your life — and make sure you realize retiring even a year ahead of schedule could mean getting hundreds less each year and potentially thousands less over your life, depending on how long you live.
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