Social Security has been part of our country’s financial system for some time, and as more baby boomers start thinking about retirement, they all have the same question: “When should I start collecting my Social Security?” The answer is different for every person because it depends heavily on one’s financial situation and retirement goals.
The Social Security system was created during the Roosevelt Administration in 1935—the height of the Great Depression—as a tool to aid the elderly and the unemployed. In our current system, benefits are issued at retirement after a lifetime of payments into Social Security. Following congressional regulations passed in 1983, the age at which you can claim full benefits is increasing. It was originally age 65, with reduced benefits available as early as age 62. Today, you qualify for full benefits at 66 years and two months old if you were born between 1955-1959, or at age 67 if you were born in 1960 or later.
Currently, there are 62 million people collecting social security—that’s one in six Americans. That ratio is sure to increase as baby boomers, the largest demographic, start to retire. There were 76 million Americans born during the baby boom between 1946-1964. The first wave of 39 million baby boomers reached age 62 in 2008. By 2031, there are expected to be 75 million Americans aged 65 or older.
No matter what your retirement plan includes, it’s essential to understand the potential impact of Social Security on your retirement budget and lifestyle. By determining how much you are eligible to collect, you can plan ahead and decide when it will be right for you to start taking advantage of Social Security.
Calculating Your Social Security Benefits
Unlike private pensions, which are pre-funded, Social Security is a pay-as-you-go plan administered by the federal government, which deducts funds from your paycheck. How much you qualify to receive in Social Security payments is determined by the amount you pay into the system, the number of years you contributed, and how early you choose to collect benefits. Here’s how the basic Social Security formula works:
First, the Social Security Administration (SSA) calculates your average indexed monthly earnings (AIME), which averages your 35 years of employment with highest earnings adjusted for inflation, then divides this amount into monthly lifetime payments.
Your AIME is used to calculate the primary insurance amount (PIA), which is matched to your age to determine your benefits. The basic PIA formula is:
90 percent of the first $896, +
32 percent of the amount greater than $896 but less than $5,399, plus
15 percent of the amount in excess of $5,399.
If you wait until you qualify for full benefits, then you will receive the full monthly allowance. If you elect to retire before or after full retirement age, then compensation is adjusted. If you retire early, your primary insurance amount is reduced 6.66 percent per year for up to 36 months, and an additional 5 percent per year beyond 36 months. If you elect to delay retirement, then you earn an additional 8 percent per year up to age 70.
Once you start collecting Social Security benefits, there also is a cost of living adjustment (COLA), which increased payments 2.8 percent in 2019.
Social Security Won’t Pay for Everything
Although Social Security will supplement your retirement income, it won’t be enough by itself. Most financial experts indicate that the average person needs about 70 percent of their pre-retirement earnings in order to live comfortably in retirement, and Social Security will only make up 40 percent. That means you will have to account for the additional 60 percent with retirement savings or other sources of income.
So, before you decide when to collect Social Security, take a look at your retirement savings. Do you have enough to retire comfortably if you include Social Security? You want to calculate how much you need to live on in retirement, including incidentals such as travel, supplemental health insurance, and other expenses. Remember that the 70 percent estimate of your pre-retirement spending is just that—an estimate—so make sure to develop a revised household budget that includes all anticipated retirement expenses.
Do you own your home? If you do, you may be able to use your home equity as part of your retirement plan. Many retirees opt to sell their home and downsize or rent, putting the profit of their home into a retirement fund. If you own a home, you may want to consider strategies to turn your home equity into retirement capital.
Another consideration is life expectancy. Ghoulish though it may seem, you also need to estimate how long you will need to live on your retirement nest egg. Today’s average life expectancy is between 85-87, although many people live longer. Your financial plan should account for how long you will need to fund your retirement, as well as any funds or assets that you plan to leave to your heirs.
Ways to Supplement Your Social Security
As part of your financial planning, you should start saving for retirement as soon as possible. There are a number of ways you can save for the future:
- Individual retirement accounts (IRAs) are an excellent way to save tax-deferred dollars for when you retire. If you want to pre-pay the taxes on your savings, consider a Roth IRA.
- Certificates of deposit (CDs), money market accounts, and savings accounts are all useful tools to help you put extra money away for the future. You can use money market and savings accounts to accumulate cash, then convert it into CDs to lock the money away at a higher interest rate.
- 401(k) and workplace pension programs are also excellent for retirement, especially if your employer offers matching funds. If you change jobs, you can always roll your 401(k) into an IRA to keep your retirement nest egg intact without tax penalties.
Planning for retirement is something everyone needs to consider. If you’d like to discuss different strategies for your retirement plan, talk to our team. We would be glad to help you develop a retirement strategy that’s right for you.