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Our family’s goal was to achieve financial independence assuming we will have no Social Security benefits. Our full retirement ages are over two decades away and future cuts are likely. We decided to consider any benefits we may receive as a bonus and haven’t paid much attention to Social Security.

Money surrounding Social Security card

I recently shared that I’ve been helping my parents with their finances as they transition into retirement. Seeing how valuable their Social Security is has been eye opening.

With a paid off home and cars and a low tax-burden in retirement, they live a comfortable lifestyle with most of their expenses covered by their Social Security benefits and a very small pension. 

They need little money from their investment portfolio. This means they could have saved substantially less and retired sooner or spent substantially more on the way to retirement.

Seeing this made me realize that ignoring Social Security can be an expensive mistake. So I sought out to answer three questions:

  1. What are our Social Security benefits as things stand today? 
  2. What impact does retiring early have on future Social Security benefits? 
  3. How should we incorporate uncertain future Social Security benefits into our financial projections?

How You Accumulate Social Security Benefits

It’s important to start with a basic understanding of how Social Security works. Social Security functions similarly to a pension, replacing a portion of your earnings. 

Your benefit in retirement is dependent on your “Taxed Social Security Earnings” over your lifetime. Social Security calculates your benefit based on the average of your highest 35 years of earnings. You must have at least ten years of earnings to qualify for Social Security retirement benefits.

The program is most beneficial to lower earners. They have a higher percentage of their income replaced by Social Security benefits in retirement. As you earn more, a smaller portion of your income is replaced by Social Security in retirement.

To better understand how you accumulate Social Security benefits and how retiring early impacts your benefits, it is important to understand the terms AIME, PIA, and bend points.

Understanding AIME and PIA

AIME are your average indexed monthly earnings. Social Security adjusts your income for inflation that occurs over your working lifetime. This ensures future benefits aren’t destroyed by inflation in the years between when you earn them and when you receive them.

For example, my first year of having taxed Social Security earnings was 1995. The $2,920 of income I earned cutting grass and making pizzas in 1995 is currently worth over double that amount, $6,163, in 2020 dollars after multiplying by 2.1106823 to adjust for inflation since 1995. 

The $82,556 I earned in my last year of working as a physical therapist in 2017 is worth $85,548 in 2020 after applying the much smaller multiplier of 1.0362449 for 2017. This smaller inflation adjustment is due to earning these dollars more recently.

You can find the inflation adjustment multipliers by year on the Social Security website.

PIA is your primary insurance amount. PIA is calculated based on your AIME over your highest earning thirty-five years. This is the basis for the Social Security benefits you will receive in retirement. 

Understanding Bend Points

The next important concept to understand is applying bend points to determine your retirement benefits. The concept of bend points is analogous to our progressive income tax system. It is designed to benefit lower earners more and be progressively less beneficial to higher earners.

The dollar amounts of your PIA change from year to year based on inflation. The percentages are fixed by law. 

Up to the first bend point, your income is replaced at 90% of your AIME. In 2020 the first bend point is $960. If your AIME is exactly $960, you will qualify for a monthly benefit of $864 at your full retirement age.

AIME above the first bend point up to the second bend point, $5,785 in 2020, is replaced at only 32%. For example, someone with a PIA of $1960 would be exactly $1000 over the first bend point. They would receive an additional $320/month. The total monthly benefit in this scenario is $1,184.

Above the second bend point up to the maximal amount, income is replaced at only 15%. Thus, you do not accrue benefits in a linear fashion. They become progressively less generous at each bend point.

Dollars earned up to the first bend point produce nearly three times the benefit of those between the first and second bend points. Those dollars in turn produce more than twice the retirement benefit of dollars earned above the second bend point.

The Impact Of Early Retirement

Retiring before accumulating 35 years of taxable earnings means having years of zero (or very low) taxed earnings factored into your average earnings. This will lower your AIME and PIA.

This is especially important if your PIA has not reached the first bend point. Up to the first bend point income is replaced at 90%. Social Security replaces progressively less of your income as your PIA passes the first and second bend points.

How much you value these benefits is an individual decision that depends on what other assets you have to support you in retirement. How much confidence you have in the Social Security system remaining viable by the time you are eligible for benefits may also impact your decision.

In any case, it is worth knowing where you stand with regards to accumulating Social Security benefits. Then, you can make an educated decision.

Differentiating Between Retiring Early And Claiming Benefits Early

Before we discuss determining what Social Security benefits you’ve accumulated, it is important to make a distinction between retiring early and claiming Social Security benefits early. They are two entirely different discussions.

Let’s focus on retiring early, meaning to stop earning or drastically reduce your taxable wages. This will impact the Social Security benefit you accumulate over your working lifetime if you have not yet accumulated 35 years of earnings. It will also impact you if you have accumulated 35 years of earnings, and if the earnings you are forgoing later in life would be greater than the earnings you have already accumulated. Either scenario will decrease the average earnings compared to your potential top 35 years of earnings.

However, retiring early will not cause you to lose any benefits you’ve already accumulated.

Claiming Social Security benefits prior to your full retirement age is an entirely separate decision. Full retirement age is currently between 66 and 67 years of age depending on your date of birth. This may be increased in the future to reflect increasing life expectancy. You can calculate your full retirement age here.

You may claim Social Security retirement benefits as early as age 62. This will reduce your monthly retirement benefit.

Conversely, you can delay receiving benefits beyond your full retirement age. In this scenario, you will claim a larger monthly benefit when you do begin. 

You can find Social Security rules related to claiming retirement benefits at this link. Darrow discussed this decision making process in detail in this blog post.

Projecting Your Social Security Benefits

You can obtain your estimated Social Security benefit by setting up an online account with “my Social Security.” You can then access your earnings records and estimated benefits on their website.

When calculating your estimated benefits, Social Security assumes you will continue to work until your full retirement age. They project future benefits based upon your earnings from the two most recent years. Therefore, the benefits you eventually receive may be more or less than the projections depending on your actual future earnings.

The website also makes it clear that the law can change between now and when you apply to receive retirement benefits. Directly from the website:

“Your estimated benefits are based on current law. The law governing benefit amounts may change. Congress has made changes to the law in the past and can do so at any time.”

This stipulation combined with projected funding shortfalls are why we haven’t placed much emphasis on Social Security planning in the past. 

Placing too much faith in your projected earnings probably isn’t wise. This is particularly true the further out you are from claiming benefits. Still, I’ve realized being ignorant and ignoring benefits you’ve earned isn’t a valid strategy either. 

Adjusting Social Security Benefits for Future Earnings

On the “my Social Security” website, you can use their Retirement Calculator to experiment with the impact of different levels of ongoing income on your Social Security retirement benefits.

My estimated benefit at full retirement age is $1,869 a month based on my twenty-five years of earnings between 1995 and 2019. Over the last two years, I’ve had very little income taxable by Social Security, totalling less than $6,000.

I first changed the calculator to assume future earnings to be $0. This had almost no effect on my estimated benefit, lowering it to $1,852 a month. 

Entering $90,000 for future earnings raised my estimated benefit by almost $1,000/month at full retirement age to $2,737. At first glance, this seems like a fair amount of money to leave on the table by retiring early. 

However, obtaining this level of benefit would require working full-time 19 more years. That would give me ten more years to complete 35 years of earnings, plus replace the eight years on my earnings record when in college and early retirement when income was less than $10,000/year, plus my first year of work as a physical therapist when I made only $22,500 working half a year. 

Next, I looked at the impact of working part-time in semi-retirement. I’ve recently written about how friendly the tax code is for semi-retirees who earn small amounts of income after leaving their careers. What is the impact of part-time work on Social Security benefits?

If I made just $1,000 a month ($12,000 a year) in semi-retirement, my benefit at full retirement age would jump by over $100/month from $1,869 to $1,981 a month. Making $2,000/month ($24,000/year) would increase my benefit to $2,144 a month.

Determining Your Inflation Adjusted Benefits

One piece of information that is not clear from the Social Security site is where your PIA is relative to the bend points. This information is important to determine how impactful working longer would be on your future Social Security benefits.

Remember, up to the first bend point, your income is replaced at a rate of 90%. Between the first and second bend points the replacement rate drops to 32%. It drops further, to 15%, beyond the second bend point.

Also, remember that both your earnings and the bend points are adjusted for inflation. Once you’re AIME has surpassed a bend point, it shouldn’t drop below it. 

Knowing where you stand will let you know how impactful more earnings will be on your future benefits, allowing you to make a more informed decision. Again, you must make all decisions related to Social Security knowing the rules can change at any point.

You can determine the relationship between your AIME and the bend points by multiplying your Taxed Social Security Earnings found in your Earnings Record by the inflation adjustment multiplier for each year

An easier way to do this is to enter your earnings record for each year into the Physician on FIRE Social Security calculator. It provides information that is hard to decipher directly from the “my Social Security” website, including the sum of your top 35 years of indexed earnings, your AIME, and whether you’ve reached the first and second bend points.

Should You Retire Early?

When you should retire and how much Social Security benefits impact that decision are complex and personal  issues that must be answered based on our individual circumstances. I’m sharing my personal numbers and thought processes to provide an example. 

There is no hard and fast rule to tell you if you are in position to retire early. There are scenarios when working more would not impact your Social Security retirement benefit at all. In other situations, retiring too soon would be an expensive decision.

When Does Earning More Not Help You At All?

Your PIA is based on your AIME from your thirty-five highest earning years. If you work beyond thirty-five years and your ongoing earnings are not greater than the inflation adjusted earnings already on your earnings record, you won’t receive any additional Social Security benefit.

Let’s use this example. You started working at age 20. Your starting salary was $50,000 a year adjusted to 2020 dollars. You never made less than that over the next 35 years. At age 55, you decide to cut back to part-time work that will pay you $40,000 a year.

You and your employer will each pay 6.2% Social Security taxes (or you will pay both portions if you’re self-employed) on that $40,000, a total of $4,960 Social Security tax. These earnings will not increase (or decrease) the size of the Social Security benefit you will qualify for at your full retirement age, because it doesn’t increase the average from your best earning 35 years.

To be clear, there are financial and personal benefits that may be derived from working longer. But the extra work and corresponding taxable income will not have any impact on the size of your Social Security earnings record in this scenario.

When Will Working More Substantially Increase Benefits?

On the flip side, there are times when working more will substantially improve your Social Security benefits. The first is common. The other two are presumably rare, but worth mentioning.

If you don’t have enough other assets to comfortably support your retirement needs, it makes sense to work longer to simultaneously allow more time to build assets, delay spending down the assets you do have, delay claiming Social Security to get a larger monthly benefit when you do claim, and increase the Social Security benefit you earn if you are completing 35 years of earnings history or potentially increase your benefit if replacing lower earning years with higher earning ones.  

Another scenario when it would make sense to work more is for those working toward an extreme “FIRE style” retirement. Those who have not achieved 10 years of earnings records, do not qualify for Social Security retirement benefits. It almost always makes sense to at least continue part-time work until you achieve an earnings record of at least ten years. Otherwise you will leave all the Social Security retirement benefits you have otherwise earned on the table.

The other scenario where it would be hard to justify not working longer is if earnings have not met the first bend point as described above. Up to that point, every dollar of AIME is replaced in retirement at a rate of 90%. This is a lot of money to leave on the table. After the first bend point, income is replaced at 32% of your AIME and then 15% after the second bend point.

The Gray Area

Many people close to traditional retirement age have few assets outside of their primary residence. They will rely heavily on Social Security to support them in retirement. Doing everything possible to optimize Social Security, both maximizing the benefit earned and optimizing the claiming decision, is wise.

Most readers of this blog do not fit that description. Many of you have accumulated significant assets to help support your spending needs in retirement. 

The question becomes whether it is worth it to work longer, knowing that as your earnings exceed the bend points you achieve diminishing returns from a Social Security program that may reduce your benefits by the time you are eligible to receive them. 

Gaining a better understanding of Social Security benefits gives Kim and I two take home lessons.

1st Take Home Lesson: The Impact of Early Retirement On Social Security Benefits

The first lesson applies to how we consider Social Security with regards to deciding on future work. 

I was able to achieve a PIA well beyond the first bend point based on a twenty-five year work history, with most of the benefits coming from my sixteen highest paid years. This gives me a projected benefit of $1,869 at my full retirement age.

In my case, working full-time for nearly two more decades would add less than $1,000/month to that benefit. That is not enough to make me regret leaving my career early. Increasing Social Security benefits will essentially remain a non-factor as an incentive for Kim, who has a similar earnings record, as she decides on how much to continue to work going forward.

Take the time to understand what your current benefits are and what impact future earnings have on them. This will help make as educated a decision as possible as the rules stand today.

2nd Take Home Lesson: The Value of Social Security Benefits

The second lesson relates to how we will project our future Social Security benefits when running retirement scenarios in our preferred retirement calculator. Previously, we underestimated how valuable the benefits could be. 

We have no way of knowing how the program will change in the future. So we just threw up our hands and ignored what Social Security benefits will mean for us.

Kim and I currently have similar earnings records. If we each get our benefits as projected, we would receive nearly $4,000/month at our full retirement age. That would more or less cover our current living expenses. 

Our Social Security benefit is valuable, even if future benefits are substantially reduced. The program is popular enough that it’s unlikely to ever completely go away. We won’t ignore it in retirement calculations going forward.

However, it is also widely known that Social Security is underfunded. It’s unlikely that we will receive our full projected retirement benefit in 20+ years when we reach full retirement age.

Moving forward, we’ll pay a bit more attention to our benefits, checking them annually. When running retirement simulations we’ll run multiple scenarios with 25%, 50%, 75% and 100% of our currently projected benefits. 

The 25% and 100% scenarios will represent our best guess at absolute worst and best case scenarios. The 50% and 75% scenarios represent our best guess on the likely range of values of our future Social Security benefits based on our knowledge of it today.

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[Chris Mamula used principles of traditional retirement planning, combined with creative lifestyle design, to retire from a career as a physical therapist at age 41. After poor experiences with the financial industry early in his professional life, he educated himself on investing and tax planning. Now he draws on his experience to write about wealth building, DIY investing, financial planning, early retirement, and lifestyle design at Can I Retire Yet? Chris has been featured on MarketWatch, Morningstar, U.S. News & World Report, and Business Insider. He is also the primary author of the book Choose FI: Your Blueprint to Financial Independence. You can reach him at chris@caniretireyet.com.]

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