How Does Retiring Early Impact Social Security Benefits?

It’s not unusual for workers to end their careers sooner than anticipated.

According to the latest data by the Employee Benefit Research Institute, an estimated 48 percent of workers are retiring earlier than intended.

Many Americans dream of leaving the workforce early to join the Financial Independence, Retire Early (F.I.R.E.) movement, but doing so can have drawbacks. To make such a crucial decision, you first need to examine the financial impact of early retirement on your Social Security benefits.

Once you crunch the numbers, you can determine whether delaying retirement by a few more years is worth being able to retire early. 

Social Security recap

Social Security is financed through payroll taxes and is meant to act as a financial safety net for all qualified workers. Every adult with an earnings history should consider setting up a personalized Social Security account to get unrestricted access to his or her estimated benefit statement. That figure may vary widely for fledgling workers but could be more accurate for those nearing retirement.

I should mention that not everyone qualifies for Social Security retirement benefits. To be eligible, you first need 40 credits. You can earn up to 4 credits every year. Most Americans make enough income to accumulate these 40 credits over their working life.

 How Social Security Payments Are Calculated

Knowing how the Social Security Administration (SSA) calculates Social Security payments is vital to understanding the impact of claiming benefits early.

The benefit is calculated from your average indexed monthly earnings (AIME). This takes into account your highest 35 earning years (indexed for inflation) and averages them out to a monthly earning. If you stop working before having 35 years of earnings, SSA uses a zero for every year without earnings to compute your retirement benefits.

Once you have the AIME, you can use it to calculate your Primary Insurance Amount (PIA). For 2021, your PIA is the sum of:

  • 90 percent of the first $996 of your average indexed monthly earnings, plus
  • 32 percent of your AIME over $996 and through $6,002, plus
  • 15 percent of your average indexed monthly earnings over $6,002.

What is full retirement age (FRA)?
Also known as normal retirement age, full retirement age is set at age 67 for people born after 1959. (Use the Social Security Administration’s (SSA) retirement age calculator to determine your FRA.)

However, you don’t have to wait that long to start receiving payments. You’re able to enroll as early as age 62. This can be a very tempting option if you plan to leave the workforce sooner than later.

For 2021, $3,113 is the maximum monthly amount of Social Security Benefits you can receive if you file at full retirement age (67). 

Early retirement will decrease your Social Security benefit

By retiring early, you will miss on your prime earning years. This will reduce your AIME – the average of your 35 highest-earning years. Social Security will reduce your monthly benefit to account for the fact that you’re receiving more payments than workers who hold off until their full retirement age.

Social Security benefits become available from as early as age 62. However, depending on your birth year, the benefits are​ permanently reduced​ by 25 percent or more. They may also be subject to earnings restrictions if you continue to work and claim benefits before your FRA.

If you retire early, the SSA reduces your benefit by 5/9 of 1 percent for every month you collect Social Security before your FRA (up to 36 months). If the number exceeds 36 months, your Social Security benefit will be further reduced by 5/12 of 1 percent per extra month.

The effect of early retirement on Social Security benefits is greater for spouses, who are eligible to get up to half of the worker’s primary insurance amount.

Patience pays

If you delay your retirement until you reach your full retirement age, your Social Security retirement benefits will increase by a particular percentage (depending on the year of birth).

At full retirement age, your benefit is 100 percent of your Primary Insurance Amount.

But if you’re willing to postpone claiming benefits until age 70, you can earn up to 32 percent in additional delayed retirement credits. The increase will cease when you reach age 70, even if you continue to delay taking your benefits.

This chart by the Social Security Administration outlines the effect of early or delayed retirement on retirement benefits.

Conclusion

Social Security operates as an income replacement formula. Waiting longer to claim could result in a bigger financial benefit.

If you’re still confused about whether or not retiring earlier than planned is the right decision, consult an independent financial advisor. By working with a financial expert, you can better understand the merits and demerits of early retirement and the impact it may have on your retirement savings and lifestyle.