Social Security: Your Retirement Benefit

Social Security benefits will make up some portion of your retirement income and for most people, it is an integral part of their retirement planning.  Learn what makes you eligible, how your benefit is determined, and what you can do to maximize the amount you’ll receive.

The Social Security Administration estimates that the average retirement benefit received by a retiree is equal to 40% of that person’s pre-retirement income.  This is a significant amount of money, but I don’t know many people who live off just 40% of their income each year.  It would require some extreme cuts to your spending to survive on Social Security alone.  Moreover, unless changes are made to the program, the benefits you expect may be reduced in the future because the number of workers paying into the system is declining in relation to the number of people receiving payments.

According to the Social Security Administration’s 2020 Annual Trustees Report, by 2034 the taxes collected to fund the program will only cover 76% of the retirement benefits promised.  If you receive your Social Security statement each year, this bit of information is prominently displayed on the document as a reminder that changes are necessary and likely to occur.

These concerns are why supplementing retirement with pensions, savings, and investments is so important.  It is also why understanding the program and how you can maximize the benefit you and your family receive are critical to retirement planning.

How You Become Eligible for Retirement Benefits  

The key requirement to becoming eligible for Social Security retirement benefits is that you pay into the system.  This is done most commonly through payroll and/or self-employment taxes.  Not paying into Social Security is uncommon, but examples of workers who are generally not covered by the program include:

• U.S. government employees covered by the Civil Service Retirement System
• Railroad employees covered by the Railroad Retirement Board
• Some state, county, and municipal employees are covered by a state-funded pension instead of Social Security
• Clergy members who have opted out of the program

To qualify for Social Security retirement benefits a person must earn 40 work credits, which usually amounts to ten years of work history.  In 2021, you’ll receive one Social Security credit for every calendar quarter in which you earn at least $1,470.  This means that you effectively only need to earn $5,880 annually for a decade to earn the required number of credits that will make you eligible to receive a benefit.

How Your Retirement Benefit Is Calculated

The Social Security Administration factors in your highest 35 years of earnings and ranks those earnings from greatest to least over your lifetime.  Unlike some private pensions that calculate benefits based on the three highest consecutive years of earnings, Social Security factors in much more of your work history and the sequence of your earnings does not matter.  If you have fewer than 35 years of earnings history, some of the years counted when calculating your benefit will be $0.  If you have more than 35 years of earnings history, the lesser earnings will drop off and be replaced with those that are higher, which will increase your benefit.

You can sign up to receive statements annually from the Social Security Administration, which includes an estimate of your retirement benefit.  The estimate shown in the statement assumes your current income will continue until retirement.  The accuracy of the estimate is much better after you reach age 60.  If you are younger, your income changes, you have a period of time where you don’t pay into the system, or you are planning to retire early, the estimate will not be as accurate.  Navigating variables such as these is one of the primary benefits of retirement planning.

When You Can Start Collecting Retirement Benefits

The earliest you can collect your Social Security retirement benefit is age 62 and you can delay up to age 70.  When discussing your benefit, the term Full Retirement Age (FRA) is an often-used term.  FRA is the age when you become eligible to collect your “full” retirement benefit, which is the unreduced amount your work history makes you eligible to receive.  For everyone born after 1960, FRA is 67.  If you were born between 1954 and 1960, FRA rises by two months for each year after 1954.  The age you begin collecting your benefit is the other primary factor that impacts how much you receive.

Collecting Retirement Benefits Before Full Retirement Age

Collecting benefits before FRA permanently reduces your retirement benefit for life, but a lesser-known consequence is that it may also affect Social Security survivors’ benefits when you pass away too.  The reduction calculation is somewhat confusing (5/9ths of 1% for the first 36 months then 5/12ths of 1% for each additional month prior to FRA).  This works out to be approximately 0.50% per month, which is equivalent to 6% per year.  For a person whose FRA is 67, starting benefits at age 62 is the same as taking benefits 60 months early. This will result in a 30% permanent reduction to monthly retirement benefits for life.  Spousal benefits that are started before FRA are reduced at an even more accelerated rate.  Additionally, collecting retirement benefits while you are still working will also reduce the amount you receive, but the reduction is only temporary.    

Collecting Retirement Benefits After Full Retirement Age

Social Security retirement benefits are permanently increased for each month you delay starting your benefits after you reach FRA.  Again, the math is somewhat confusing.  The rate of increase is 2/3rds of 1% per month, which is equivalent to 8% per year.  For a person whose FRA is 67, starting benefits at age 70 is the same as delaying benefits 36 months. This will result in a 24% permanent increase to monthly benefits for life.  Moreover, by delaying the start date of your benefits, your earnings history is expanded, which depending on your income, may replace lower-earning years that are being counted in the 35 years of earnings history that Social Security uses to determine your benefit.  Benefits do not increase beyond age 70, so there is no advantage to delay collecting benefits beyond this age.

Cost-of-Living Adjustments

Since 1975, Social Security retirement benefits are subject to annual cost-of-living adjustments (COLA) based on changes to the Consumer Price Index.  The specific index used is the CPI-W, which accounts for price changes for Urban Wage Earners and Clerical Workers.  Notably, the CPI-W includes changes to the price of food and energy, which tend to be more volatile and impactful to consumers.  If the index is negative or unchanged for the year, a COLA is not made to Social Security benefit payments in the year that follows.  Notices regarding the adjustments that will be made in the upcoming year are sent out each December to those already collecting benefits.  In 2021, benefit payments were increased by 1.3%.  All recipients of Social Security retirement benefits receive the COLAs.  Such increases are valuable to maintaining one’s standard of living in retirement and are much less common in private pensions, which are becoming increasingly rare over time.