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Understanding Social Security Benefits in Early Retirement
By: Geordie Crossan

For one out of every three retired Americans, Social Security is the only source of retirement income. For two out of three, it provides at least half of the retirement income. Moreover, about 60 percent of workers intend to retire early and take Social Security retirement benefits beginning at age 62. So what’s wrong with this picture? Those who tap into Social Security at the young age of 62 will experience a permanent reduction in their annual benefits by 25-30 percent. What’s worse is that only 27 percent of these people have begun planning for retirement. That’s one important reason why prospective retirees need to understand the impact and breakeven points of taking benefits early rather than waiting until full retirement age.

Full Retirement Age Is Changing
Prior to 2000, the age at which people could retire with full benefits was 65. Those who retired at 62 had their benefits reduced by 20 percent for the remainder of their life. Beginning in 2000, the full retirement age is gradually increasing to 67 by 2022. Consequently, the reduction in benefits also increases each year to a maximum of 30 percent in 2022.

For example, for people born between 1943 and 1954, the full retirement age is now 66, which means they will experience a 25 percent reduction in benefits if they retire early. For people born 1960 and after, the full retirement age is 67, which means a 30 percent reduction in early benefits. Note that early retirement age remains unchanged at 62 and the age to begin receiving Medicare benefits remains unchanged at 65.
Breaking Even

Who comes out ahead — the early retiree who receives benefits starting at 62, or someone who waits a few years to get full benefits? According to the Social Security Administration’s actuarial tables, it’s a wash. Calculations of breakeven points, however, tell another story. For an individual who retires at 62 in 2008 (with a 25-percent reduction in benefits) rather than waiting another 48 months for full benefits at 66, the breakeven point is 78. If the individual lives to 78, early benefits and full benefits equal each other. Factoring in the time value of money, assuming a four-percent rate of return, the breakeven point increases. Now the individual would have to live to 84 to make waiting for full benefits worthwhile. With a full retirement age of 67, the breakeven points are 78 and 85, respectively, for nominal dollars and time value of money calculations.

Individuals may defer taking benefits up to age 70 for an eight-percent increase in benefits each year. Doing so only makes sense given access to other income and a high life expectancy.

Employment and Tax Considerations
In 2008, an individual who is taking early retirement benefits and has employment income in excess of $13,560 annually loses one dollar of benefits for every two dollars of earned income above that threshold. For the year in which one reaches full retirement age, the income threshold is $36,120 in 2008. For every three dollars earned above that limit, benefits are reduced by one dollar.

Taxes on Social Security benefits are calculated based on “provisional income,” i.e., one half of Social Security benefits plus other taxable income plus tax-exempt income. For individuals with provisional income under $25,000, benefits are not taxed. For married couples filing jointly, benefits are not taxed if provisional income remains under $32,000. Above these limits, 50 percent of Social Security benefits are taxable up to the next threshold. Eighty-five percent of Social Security benefits are taxable for single individuals whose income exceeds $34,000, and for married people filing jointly, $44,000.

Spousal Benefits
A spouse is entitled to his or her own Social Security benefits based on work history, or 50 percent (35 percent for early retirees) of the partner’s benefits, whichever is greater. A surviving spouse is entitled to 100 percent of the deceased partner’s benefits, or 71.5 percent if retiring early at age 60.

Know the Score
According to the Social Security Administration, Social Security benefits provide on average 42.5 percent of total retirement income while individual savings and investments provide 36 percent and employee retirement benefits, 21 percent. Most people assume they are going to need only 70 to 80 percent of their pre-retirement income to maintain their lifestyle in retirement, but surveys have found that people actually spend 100 percent of their pre-retirement income, at least in the early years of retirement. Given the huge reliance on Social Security benefits for income, the decision to retire early and having one’s benefits reduced by 25-30 percent should not be taken lightly.

Please contact the Social Security Administration directly to discuss your specific situation and benefit options.

Geordie Crossan, CFP is President of NBS Financial Services, Inc. For further information, visit or call 805 497-2497.