Social Security and Your Retirement – Part 1: The Basics

Over the next couple months, I will discuss the various dimensions of Social Security.  So many people look at the Social Security program as the simple process of going in to the Social Security Office to claim benefits sometime after age 62, when they decide to stop working. This is putting the cart before the horse in that they have not factored Social Security’s impact on their retirement cash flow into their decision of when to retire. The Social Security program has a complex set of rules that if understood, can influence the when-to-retire decision and a person’s retirement lifestyle. First the basics, let’s say someone owes you money and they have agreed to pay you a certain amount at a defined time in the future. For your benefit, you and this person also agreed on some leeway in these terms – a sliding scale for getting your money earlier or later than the agreed upon date. If you called as soon as the agreement allowed and said that you wanted your money, they only have to pay you 75% of the agreed upon amount.  If you tell them you want them to pay you at the very latest date then they will pay you 32% more than agreed.  When you get your money back really depends on when you need it.  If you find yourself in a financial bind you will likely ask for it early and accept the discounted amount. If you don’t need it at all, you may be happy to wait until the very latest to get the surplus. Social Security works in a similar manner. The agreed upon amount is your “Primary Insurance Amount” (or PIA). The date upon which you will receive 100% of your PIA is what Social Security calls your “Full Retirement Age” (or FRA). Everybody retiring now has a FRA is between ages 66 and 67. Anyone born after 1960 has a FRA of 67.  As long as a person works and pays Social Security taxes for 40 quarters (10 years) they are eligible for the standard PIA based on how much they paid in over the years (survivor benefits and disability benefits are a whole other discussion). Social Security has a sliding scale like our loan example, if you want your benefits before your FRA, then you may get as little as 75% of your PIA.  If you wait until age 70, you are entitled to get 132% of your PIA. Whether in a financial bind or not, the most popular age for starting to receive social security benefits is 62 – the earliest age possible for most people. Approximately 32% of men and 38% of women begin receiving benefits soon after they reach 62. The average age of when people apply for benefits is 64 so the majority apply for benefits before their full retirement age and accept some degree of reduced benefits. Only 2% of applicants wait until age 70 to get the greatest benefit possible. Some might have a legitimate financial need to apply early, but many are probably just tired of working and want to start retirement as soon as possible.  For whatever reason, it would be safe to say that there are a lot of people out there not putting much thought into when they begin to receive benefits. This is unfortunate because unlike the loan example where only one payment was made, Social Security pays month after month. The decision to start receiving benefits early or late is therefore reinforced every month. Many people depend on Social Security for a significant part of their retirement income and as such, the level of their benefit greatly influences their retirement lifestyle. In my next blog entry we take a look at the impact of claiming benefits before one’s FRA.