Will You Collect Social Security Benefits
Before Age 66?

Good Morning Relaxing Retirement Subscriber,

A new Relaxing Retirement member had a host of questions surrounding social security this past month, and it’s been a while since we’ve discussed it, so I thought it would be a good idea to share my thoughts with you as these are questions I receive all the time.  (To protect their privacy, I’ll refer to them as Bill and Madeline)

Since they were both age 64, one of their first questions was, “should we start collecting social security now, or wait until age 66?”

As I explained to Bill and Madeline, there are 2 major factors to consider before collecting social security benefits before your “full retirement age” (see below):

#1 The “Penalty”

To begin with, the reason why Bill and Madeline have a decision to make is because they’re both 64 years old, and Bill still wants to work a little when he retires from his full-time job this month.  (A very common phenomenon we see)

He was told that there is a penalty for taking his social security benefits if he still earns income from work.

He’s partially right.  There’s a lot of confusion about what those penalties are, so let’s quickly outline the limits.

First, when you reach the FRA “full retirement age” (social security’s definition of full retirement age is age 66 for 99% of those who are reading this), you can earn as much as you want from work (earned income) and still receive your full social security benefits without any reduction in benefits.

How Social Security Defines “Income”
When Calculating Your Pre-Age 66 Benefits?

Only income you receive from work, whether that income is reported on a W-2 or 1099, is counted for social security income calculation purposes,

Income you receive from pensions, rental property, dividends and interest, and capital gains do not factor into the equation.

Between Age 62 and Full Retirement Age (FRA)

As Bill is facing right now, the dilemma comes when you want to begin collecting benefits before your FRA “full retirement age”.

Currently, from age 62 to 65, you lose $1 of social security benefits for every $2 of “earned” income over $17,640 (in 2019).  That’s $1,470 per month.

So, for example, in Bill’s case, since he’s 64, if he continues to work part-time, and he earns $17,640 from his new part-time job, he can still collect his social security benefit without any reduction in benefits penalty.

However, if he earned $41,640 from his part-time job, that’s $24,000 over the limit, so social security would withhold $12,000 (or $1,000 per month) from his social security benefits (i.e. $1 withheld for every $2 you earn over the limit).

When Bill turns 65 in next year, those penalties are reduced between his 65th birthday and his full retirement age (66): he would lose $1 in benefits for every $3 he earns in excess of $3,910 per month/$46,920 per year.

So, if you’re like Bill and you are planning on still working after you “retire”, you’ll want to consider these limits.

Bill’s Earnings Limit When He Starts To Collect

An important distinction to note, however, is that you can earn as much as you want during the year you’re going to start collecting.  These limits only apply on a monthly basis once you start collecting social security benefits.

In Bill’s case, he’s 64 years old this year.  If he retires at the end of September, and he has already earned $170,000 this year through September, the “earnings” litmus test does not apply to the $170,000 he’s already earned in 2019.

It only applies during the first month he begins collecting benefits.  So, from October through December, he can earn an additional $4,410 ($1,470 x 3 months) and still collect his social security benefits without a reduction in benefits “penalty”.

#2: The “Math” Behind the Decision

The second factor to consider is the math.  For the sake of the example I’ll use here today, let’s assume for a moment that Bill and Madeline are actually age 62 (not 64) as that is the age at which Americans may now begin receiving social security retirement benefits.

Since Bill is the one considering working part-time after he retires from his full-time job, he’s the one we are going to focus on today.  Madeline’s decision is actually different and we’re going to expand on her options in a little while.

Bill’s social security benefits statement shows that his monthly benefit at age 66 will be $2,000 per month.  And, if he begins collecting at age 62, his benefit will be $1,500 per month (75% of his age 66 benefit).

If Bill starts collecting now, he’s going to take a 25% pay cut!  That doesn’t sound too great, does it?

However, he really needs to take a look at the math for a moment:

  • Monthly Benefit at age 66 (if he waits) $2,000
  • Monthly Benefit at age 62 (today) $1,500

If he takes his benefit today, Bill is going to receive $500 less per month.

What That Really Means

As I pointed out to Bill and Madeline, if they decide to wait until Bill reaches age 66, what they’re really saying is that it’s worth it to wait 4 years (or 48 months) to get the extra $500 in the 49th month and beyond.

However, another intelligent question to ask is “what are they giving up by waiting”?

What they’re giving up is 48 months (4 years from age 62 to age 66) of social security benefits.  That’s $72,000!

Not an insignificant number.

The “Break Even” Age

In order to recoup that $72,000 that they would give up by waiting until age 66, Bill would have to live another 144 months after age 66, or 12 years, at which time he’d be 78 years old.  ($72,000 divided by the incremental increase of $500 at age 66 = 144 months)

So, in order to break even, Bill and Madeline would have to live another 16 years (4 years from age 62 to 66 + 12 years = Age 78).

And, this doesn’t take into consideration 3 other factors:

  1. Bill and Madeline are eligible to receive a cost of living increase each year on their social security benefits, so their benefits will begin increasing after their first year of collecting.
  2. If Bill and Madeline begin collecting at age 62, they could invest their monthly check and potentially earn even more.
  3. Finally, and this is the most important factor in maintaining their lifestyle sustaining income over the rest of their lives, if they don’t draw from social security right now, they must draw income from some other source, i.e. their Retirement Bucket of investments.

Delaying social security reduces their inflation fighting investments more rapidly, and reduces the amount their heirs will receive at their death because social security benefits end at your death.

And, if the majority of their investments are in IRAs or other retirement plans, it may potentially reduce them even faster because they have to pay income taxes on 100% of what they withdraw vs. a maximum of 85% of their social security income.

Other Factors For Bill and Madeline To Consider

While Bill and Madeline’s example should give you a good guideline to use, here are some other factors which may affect your own unique situation:

  1. Life Expectancy: Bill and Madeline are both in good health and have no overriding problems.

    The reason why this is a factor in their decision is that if they have health issues that are predicted to shorten their life expectancy, clearly this should lead them to collect benefits as early as they can get them.

    As it was in Bill and Madeline’s case, however, if everyone in your family has lived well into their 90s, this may pull you in the opposite direction.

  1. Severance: If you’re collecting severance pay from the employer you’re retiring from, this may alter your desire to begin collecting right now because of the taxes you’ll pay on your social security benefits while you’re also receiving large severance pay.
  2. Deferred Compensation: This same principle applies to deferred compensation. Let’s say that for the 5 years prior to your retirement, you’ve contributed to an executive deferred compensation plan.  If the plan calls for you to receive a payout immediately upon retiring, as many of our members do, this may have adverse tax consequences on your social security benefits.
  3. “Other” Income: If you have other “locked in place” income, you have to weigh the after-tax benefits of collecting social security benefits early.

This dovetails into a major principle that I recommend, and that is to never make any decisions concerning benefits or investments without also simultaneously considering the tax consequences.

This is a monumental mistake that I see in way too many situations.

As you can see, there are several factors that went into Bill and Madeline’s decision.  Hopefully, their example provided a good line of questions for you to answer in your own unique set of circumstances.

Next week, I’m going to delve into the questions Madeline had about collecting her social security benefits.

Surprising to many, benefits collected by working and non-working spouses vary greatly if you don’t know the rules.

I look forward to speaking with you and clarifying those rules next week.

Stay tuned.

Committed To Your Relaxing Retirement,

Jack Phelps
The Retirement Coach

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(The content of this letter does not constitute a tax opinion. Always consult with a competent tax professional service provider for advice on tax matters specific to your situation.)