Social Security was originally developed to be just a retirement safety net, but over time benefits grew and the system now covers an estimated 96% of Americans and makes up an average of 40% of a typical retiree’s income.
This is no small drop in the bucket when it comes to your retirement income, which means Social Security benefits and claiming strategies need to integrate into your financial plan.
No matter how much you have saved towards retirement, Social Security will probably play a significant role in your retirement income strategy. And in the midst of disappearing pensions and seemingly fickle markets, Social Security provides government-guaranteed income that isn’t subject to market risk, cannot be outlived, and will help support your family after your death.
Due to its unique benefits, it is vital that you are well informed and do not underestimate the importance of Social Security in your retirement strategy. As we discussed in our recent podcast, Social Security has been around since the Great Depression but its rules are always evolving — making it a confusing retirement benefit for many people. Consequently, if you have yet to contemplate how your Social Security benefit will impact your financial plan, now’s the time to evaluate your benefits.
How Benefits Are Calculated
Social Security benefits are calculated based on lifetime earnings. First, you have to have worked at least 10 years to be eligible to receive Social Security benefits. If you have not worked at least 10 years, you will not have enough “credits.” You are awarded one credit for each $1,260 you earn (the amount changes annually), with a maximum of 4 per year. Forty credits are required to receive Social Security benefits. You can request information from the Social Security Administration to determine how many credits you have earned.
The Social Security Administration uses 35 years of earnings to calculate your benefit. If you’ve worked more than 35 years, they use the 35 years in which you earned the most. If you worked less than 35 years, it is still calculated based on 35 years, with zero earnings averaged in for the years in which you did not work. Your 35 years worth of wages are adjusted, or indexed, to match today’s wages, reflecting wage growth. Based on your adjusted wages, an Average Indexed Monthly Earnings (AIME) is calculated.
Finally, the Social Security benefit formula is applied to AIME to find your Primary Insurance Amount (PIA), which is the benefit payable to you at Full Retirement Age (FRA). Your PIA can be increased or reduced depending on when you choose to begin receiving benefits. Whether or not you decide to start receiving benefits, in the year you turn 62 you are eligible for cost-of-living benefit increases. When you choose to receive your benefits does not affect the amount of your cost-of-living increase.
The Value of Social Security Payments
The average Social Security retirement benefit payment is about $1,300 per month, but the maximum benefit at full retirement age for 2016 is $2,639 per month. For those who wait until age 70 to start receiving payments, you can potentially receive a maximum monthly payment of $3,576 (according to 2016 rules).
As Social Security payments increase with Cost of Living Adjustments, the monthly benefit will continue to grow during your retirement. Even if you don’t need Social Security payments to live on during retirement, you can invest the benefits or gift them to your heirs. This is why it’s so critical that you plan ahead to maximize your benefits and aim to use the asset as part of your overall financial plan.
When to Claim Your Social Security Benefits
Social Security benefits can be claimed anytime between ages 62 and 70. However, your age when you choose to collect benefits will impact the amount of benefit you receive.
If you choose or are forced into an early retirement, you can begin receiving Social Security benefits as early as age 62. However, if you file to receive benefits any time before reaching your full retirement age (FRA), you will receive a reduced benefit. Your basic benefit is reduced a fraction of a percent for each month you begin receiving benefits prior to full retirement age, up to 30%.
Full retirement age (FRA) changes based on the year you were born. For those born in 1937 and earlier, FRA is 65. After 1937, two months is added each year until FRA becomes 66 for those born between 1943 and 1954. Starting in 1955, two months a year is added again until the FRA becomes 67 for those born in 1960 or later. If you wait until you reach full retirement age to begin collecting your Social Security benefits, you will receive your full Primary Insurance Amount, which is the full benefit that you have earned.
You may also choose to continue working past your FRA or delay receiving your Social Security benefits. For each year that you delay, your benefit will increase 8%, for a maximum possible increase of 32%. Your benefit is only increased until you begin receiving it or you turn 70, whichever happens first.
If you’re married, spousal benefits also play into your decision-making process. Generally speaking, the lower earning spouse may decide to start collecting benefits early while the higher earning spouse plans to wait as long as possible. This allows a couple to make use of the lower benefit while maximizing the greater benefit.
Social Security and Your Financial Plan
Social Security is a unique benefit because the payments are guaranteed by the government to last throughout your lifetime and increase with inflation. Unlike some other assets, the value increases with higher than expected inflation. Because your Social Security asset behaves differently than other investments within your portfolio, the total benefit and claiming strategy should be considered when investing your other retirement resources.
If this sounds confusing or overwhelming, you’re not alone. Social Security is a complex benefit and how and when you claim can significantly impact what you receive. It’s easy to make a mistake when it comes to Social Security and we discussed 5 big Social Security mistakes to avoid in an earlier post.
If you’re working on your financial and retirement plan and are stumbling on Social Security benefits, I encourage you to reach out to us. We are happy to help answer your questions and talk about how your Social Security benefits will play into your retirement. You can call our office at (913) 624-9548 or email me at BKeen@KeenWealthAdvisors.com.
Bill Keen is a Chartered Retirement Planning Consultant® and independent financial advisor with more than 24 years of industry experience. As the founder and CEO of Keen Wealth Advisors, a registered investment advisory firm, he specializes in providing personalized retirement planning designed to help people thrive before and during their retirement years. With a passion for educating others, Bill regularly blogs about retirement planning, hosts the podcast Keen on Retirement, and has contributed to U.S. News and World Report, Reuters, Wall Street Journal’s Market Watch, Yahoo Finance, and other publications. Based in Overland Park, Kansas, Bill and his team work with clients throughout the greater Kansas City area and across the nation. To learn more, connect with him on LinkedIn or visit www.keenwealthadvisors.com.