Just two days ago on Jan. 1, Social Security marked its 80th anniversary of making payouts to retired workers. Today, it's a program responsible for divvying out more than 64 million benefit checks each month, many of which wind up in the hands of seniors.
Just how important is Social Security to these retirees? According to data from the Social Security Administration (SSA), some 62% of retired workers receive at least half of their income from the program. Furthermore, over 15 million retired workers are being pulled out of poverty each month because of their payouts, based on an analysis by the Center on Budget and Policy Priorities. Suffice it to say that deciding when to begin taking your Social Security payout can have a big impact on your financial well-being later in life.
Deciding when to take Social Security is the most important decision seniors will make
Although there are more than a half-dozen factors that can ultimately affect what you'll receive or get to keep from Social Security, there are four factors that really stand out. The first two, your work history and earnings history, are inextricably tied at the hip. The SSA will take your 35 highest-earning, inflation-adjusted years into account when determining your benefit at full retirement age. This is why working at least 35 years is so important; otherwise, zeros are averaged in for each year when you didn't work.
The third factor that helps calculate your payout is your birth year, which is what's used to determine your full retirement age -- i.e., the age at which you're able to collect 100% of your monthly payout. For most Americans, their full retirement age is 66, 67, or somewhere in between. Put simply, taking your benefit prior to reaching your full retirement age means accepting a permanent reduction. Conversely, waiting until after your full retirement age to begin receiving your benefit can boost it above 100%.
The last and arguably most important factor is your claiming age. Although eligible beneficiaries can begin taking their payouts as early as age 62, Social Security incents patience. For every year an individual holds off on taking their benefit, their monthly payout will grow by up to 8%, up until age 70. All things being equal, such as work history, earnings history, and birth year, a person claiming their benefit at age 70 could net up to a 76% higher monthly payout than an individual taking their payout as soon as possible (age 62).
With this information in mind, waiting probably sounds like the way to go, but this is often not what we see.
More retirees than ever could choose to claim Social Security early this decade
Data from the SSA shows that a vast majority of Social Security beneficiaries (around 3 in 5) claim their payouts prior to turning 66. This means most retirees are knowingly accepting a permanent reduction in their monthly payout for life. And the crazy thing is, this trend of filing early for Social Security benefits could actually accelerate throughout the 2020s.
If you're wondering why beneficiaries would purposefully take their payouts early knowing full well that their benefits would be reduced for life, look no further than the annually released Trustees report. Every year, the Social Security Board of Trustees releases its short-term (10-year) and long-term (75-year) outlooks for the Social Security program. Since 1985, the Trustees report has cautioned that long-term revenue generation would be insufficient to cover program expenditures.
In the 2019 report, the Trustees estimated a $13.9 trillion cash shortfall between 2035 and 2093, with 2020 being the first year since 1982 where the program would spend more than it brought in. The report also projects that Social Security's nearly $2.9 trillion in asset reserves (essentially, its aggregate net-cash surpluses since inception) would be completely exhausted by 2035.
In layman's terms, this means lawmakers have 15 years or perhaps even less to resolve Social Security's funding shortfall. Although Social Security won't go bankrupt, a lack of asset reserves would force an across-the-board cut to benefits that, for retired workers, could total up to 23%.
The reason soon-to-be retirees might choose to take their payouts sooner than later is simple: They fear a 23% cut to their benefits and have little or no faith in a divided Congress to fix the issue at hand.
Is claiming early a smart move?
Of course, the question that should be asked is whether front-running possible benefit cuts and pocketing as much Social Security income as possible is a smarter move than waiting and counting on Congress to resolve Social Security's cash shortfall. I'm not certain it's the right move.
Although there are a handful of scenarios where an early Social Security claim can make a lot of sense, taking your payout early because you expect Congress to drop the ball probably isn't one of them. To begin with, if we look back at Capitol Hill's track record, it has come to the program's rescue with bipartisan solutions before. Chances are that, despite the political divide that currently exists in Congress, lawmakers will work out a plan to resolve the program's funding shortfall before 2035.
What's more, waiting has been shown to be a statistically smarter move for most retirees. A report from United Income that examined around 2,000 senior households found that 70 was the optimal claiming age for a whopping 57% of seniors and more than 4 out of 5 would have benefited by waiting until at least age 67 before taking their payout. Comparatively, less than 7% of retirees would have made an optimal claiming decision by taking their payouts between ages 62 and 65.
It should also be noted that a retired worker benefit is only designed to replace about 40% of the average workers' wages during retirement. In other words, it's not meant to be a primary source of income. As long as you're saving and investing for your future and have other sources of income or savings to lean on during retirement, a future cut to Social Security benefits won't prove devastating.
My suggestion would be to really think twice before being lured into taking your payout early because you believe a Social Security benefit cut could be coming.
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