Last year, 66 million Americans received social security payments, including 5.5 million new applicants. For more than half of those individuals, social security payments accounted for at least 50% of their annual income. If you aren’t currently receiving social security benefits, you likely will one day and it will play an important role in your retirement strategy. 

In order to incorporate social security into your overall plan, it’s important to first understand how your payment will be calculated. It is equally important to plan strategically for the years you will actually draw benefits; either drawing early (as soon as 62), or postponing (as late as age 70). Finally, for married filers, you must consider your spouse’s benefit. A spouse with substantially higher earnings years will increase your benefit and at some point, a surviving spouse will only receive one social security payment. 

 

The Social Security Administration uses a formula to determine your benefit. Initially, your lifetime earnings are indexed to account for wage inflation over the years, up to the maximum earnings number. For example, if you earned $60,000 in 1990 you would only be credited for $51,300. This is the maximum wage for that year. Additionally, the index factor for that year, as of 2016, is 2.29. The inflation factor is meant to adjust the numbers to today’s dollars. Put differently, a wage of $60,000 in 1990 is considered the equivalent of $137,400 in today’s dollars ($60,000 times 2.29). For purposes of estimated benefits, you would only be able to receive credit for $117,477 (The maximum wage of $51,300 times the factor of 2.29). 

Each year has different index factors and maximum wages. Currently, the maximum wage for social security consideration is $118,500 and the inflation factor is 1. Obviously, $118,500 in today’s dollars is $118,500 ($118,500 times 1). 

Your 35 best earning years are used in this formula. Once indexed to a current wage, those numbers are totaled and divided by 420, the number of months in 35 years. This number is your average indexed monthly earnings and forms the basis for the social security benefit calculation. There are lots of tools online to help you estimate your benefits, but actual statements for your own benefit can be downloaded at ssa.gov. 

Importantly, you need to realize that additional working years, assuming you are earning more than your lowest earning years, can have a substantial affect on your benefit. 

Consider the chart below. Working an additional two years would remove the lower earnings years from the equation. This can be especially important for an individual who may not have 35 working years. 

35 Best Earning Years	Year	Wages
	1981	$46,577.63	Removed
	1982	$48,491.98	Removed
	1983	$50,485.00
	1984	$52,559.93
	1985	$54,720.14
	1986	$56,969.14
	1987	$59,310.57
	1988	$61,416.10
	1989	$63,596.37
	1990	$65,854.04
	1991	$68,191.86
	1992	$70,612.67
	1993	$72,342.68
	1994	$74,115.07
	1995	$75,930.89
	1996	$77,791.20
	1997	$79,697.09
	1998	$81,679.66
	1999	$83,650.08
	2000	$85,669.51
	2001	$87,413.50
	2002	$89,161.77
	2003	$90,945.00
	2004	$92,763.90
	2005	$94,619.18
	2006	$96,511.56
	2007	$98,441.80
	2008	$100,410.63
	2009	$102,418.84
	2010	104,467.22
	2011	$1406,556.57
	2012	$108,687.70
	2013	$110,861.45
	2014	$113,078.68
	2015	$115,340.25
	2016	$117,647.06	Added
	2017	$120,000.00	Added

 

 

As important as understanding your benefit is understanding when to file. Just because you’re retired doesn’t mean you need to file for social security. In fact, depending on other factors, like pensions and savings, it may not make sense to file yet. 

Basic benefits are calculated based on what the Social Security Administration calls full retirement age. Historically, that has been age 65. In recent years, the age has gone up. For those born after 1960, full retirement age is 67. For people born earlier than that or after 1937, full retirement age is between 65 and 67. Regardless, you can collect benefits as early as 62 or as late as age 70. 

Drawing benefits at age 62 comes with a hefty penalty, a 30% reduction to your benefit.  Consider a monthly benefit of $2,559 (full retirement age amount). At age 62, this payment would be reduced to $1,788. Alternatively, delaying your benefits will increase them by roughly 8% each year. That same $2,559 at age 65 become $3,186 if delayed until age 70. 

These choices have far-reaching implications. Remember, this is a choice you have to live with for the rest of your life (or longer in the case of a surviving spouse that earned less than you). Generally speaking, social security will increase each year based on CPI (consumer price index), which is historically 2%. Using the same example as above, choosing to draw social security at age 62 ($1,788) would result in a monthly payment of $2,604 20 years later. Compare that to someone who waited until age 70 to collect ($3,186) with the same earnings record. Twenty years later their monthly benefit would be $4,641!

As mentioned before, married couples need to consider each other’s benefit. Importantly, a spouse with substantially lower earnings, or a spouse that didn’t work outside the home, will be able to collect based on the other spouse’s earning record. The spouse with the smaller benefit will receive at least half of the higher earning spouse’s social security. Of course, if their own benefit is larger than half, then they receive their own social security. Also, divorced spouses can collect benefits based on their ex’s earnings record if they were married for at least 10 years. 

Finally, choosing to delay social security can be an important factor for legacy planning. When one member of a married couple passes away, the surviving spouse will not continue to collect both their benefit and their spouse’s benefit. They will only receive whichever one is larger. Consider the two benefits from earlier, $2,604 and $4,641. Deciding when you draw social security is an important factor when planning on taking care of your survivors! That being said, widows and widowers can also choose to collect their spouse’s benefit instead of their own when they retire. 

 

When you decide to collect social security you should also consider your Medicare filing strategy, as well as how it fits into your overall tax profile. Working with a certified professional is the best way to navigate any major financial transition. 

 

 

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