Social Security gives workers the option to take benefits anytime between the ages of 62 and 70, and it offers some incentives to those who are willing to wait.
Waiting eight years to claim Social Security at 70 instead of 62 can boost monthly payments by more than 75%. Yet 57% of Social Security recipients take their benefits before reaching full retirement age. Those who draw early believe that the benefit of having the money now instead of waiting outweighs the increased monthly payment.
How Social Security Benefits are Disbursed
Social Security was designed so that regardless if a worker starts receiving benefits earlier or later, he or she should receive about the same total money over their lifetime. However, this depends on how long the worker lives. The breakeven age generally ranges from 77 to 83, depending on when benefits start. Anyone living beyond age 83 will receive more benefits by waiting until age 70 to begin his or her Social Security. According to data compiled by the Social Security Administration:
- A man reaching age 65 today can expect to live, on average, until age 84.0.
- A woman turning age 65 today can expect to live, on average, until age 86.5.
And those are just averages. About one in every three 65-year-olds today will live past age 90, and about one in seven will live past age 95.
Understanding the Earnings Test
I’ve frequently written about the factors to consider before beginning to draw Social Security benefits. One of the most important factors for someone planning to draw benefits early is the Social Security earnings test. For the purposes of this newsletter, “drawing early” means collecting benefits before a worker reaches full retirement age (FRA). FRA will depend on the worker’s year of birth and today is generally age 66 to 67. A worker drawing early will be subject to the earnings test. The earnings test is designed to deter a worker from drawing benefits before they are fully retired.
The earnings test only looks at earned income from employment. Earned income includes wages or self-employment income (only income subject to Social Security taxes). This is the gross amount of income from earnings not reduced by contributions to retirement accounts. A worker can have an unlimited amount of other income without impacting their Social Security benefit, provided none of the income consists of earnings from employment. Pension income, distributions from retirement accounts, and investment income, such as interest, dividends, and capital gains, all have no impact on the earnings test.
In 2019, employment earnings begin to impact benefits once earnings exceed $17,640. This income threshold is adjusted annually for inflation. The Social Security Administration reduces benefits by $1 for every $2 of earnings above the threshold. Benefits could be reduced all the way to zero if earned income is too high. This reduction applies to the worker’s total annual benefit, not the monthly benefit.
This formula changes in the year the worker reaches FRA. The earnings test has a separate threshold amount for this year only. During the year a worker reaches FRA, he or she may earn up to $46,920 (in 2019) before any benefits are withheld. The formula for withholding benefits also changes to $1 of benefits for every $3 of earnings over the threshold. The earnings limit stops once a worker reaches the month in which they attain FRA, allowing them to earn an unlimited amount of money without impacting benefits. The higher threshold amount is not prorated. The worker may earn $46,920 prior to their FRA month without an impact to their benefits.
The first year of early retirement is considered a grace year for purposes of the earnings test. If a worker has already earned substantially more than the threshold amount for the year, they can retire and begin to receive unreduced benefits provided they earn less than the monthly limit the rest of the year. The monthly limit in a grace year is simply a worker’s annual threshold, divided by 12. In 2019, the threshold for a worker below FRA is $1,470 ($17,640 / 12) and $3,910 for a worker reaching FRA during the year ($46,920 / 12).
The grace year rule is generally easy to determine for a worker earning wages because they have a paycheck to determine when income is earned. It is a little trickier for self-employed workers. The Social Security Administration evaluates whether the worker provided “substantial services” during the month. The administration defines substantial service as devoting more than 45 hours per month to the business, or devoting more than 15 hours per month to the business if it is a highly skilled occupation.
It is important to note that the earnings test only applies to the individual worker’s own Social Security retirement benefit earned via their own work history. Only that worker’s earnings will impact their retirement benefit. A spouse’s earned income will not affect a worker drawing early benefits (pre-FRA) for purposes of the earnings test.
There is a silver lining to this story for workers who have already been impacted by the earnings test and had to give back some of their benefits. Those benefits are not actually lost. The “lost” benefits are added back to the worker’s subsequent benefits when they reach FRA. The dollars are not returned in a lump sum. For every month benefits are skipped due to the earnings test, one month’s penalty for claiming Social Security benefits early will be “reversed” at FRA. Thus, the ultimate loss caused by the earnings test rule depends on how long the worker lives after reaching FRA. The breakeven point goes back to the age range mentioned earlier. It is possible for the earnings test to deliver more benefits to a worker who lives past age 83. In a sense, the earnings test is a form of forced delayed retirement, compelling a worker who claimed benefits early to wait until FRA to get the benefit they would have received had they not claimed early.
The bottom line is that reaching FRA tends to resolve a lot of issues when it comes to Social Security planning. Workers who have income from employment generally should wait until FRA to start drawing benefits.
- Waiting until age 70 can boost monthly Social Security payments by more than 75% versus drawing early at age 62.
- The Social Security earnings test looks only at earned income from employment.
- Only the earnings of a worker drawing benefits will be counted for the earnings test. A spouse’s earned income is not used.
1. Fast Facts & Figures About Social Security, 2018. SSA.gov
2. Social Security Benefits Planner – Life Expectancy. SSA.gov