At What Age Can You Continue to Work and Not Be Penalized on Social Security
In this article, I examine the choice of receiving U.S. social security payments prior to the ordinary retirement age. For convenience, I'm going to consider the case of someone that was born in 1957 and that is considering whether to begin receiving Social Security at about the time that they reach the age of 62. In this case, the monthly payments that the individual receives will be 27.5% lower than they would have been if the individual had waited until turning 66.5.
Individual circumstances vary and it is difficult to generalize. Nevertheless, I have identified four categories of 62-year-old investors:
- Those who do not have a full-time job. For many of these investors, starting Social Security at 62 probably makes sense in many cases.
- Those who are keeping working until they are eligible for Medicare. For many of these investors, starting Social Security early probably would not make sense.
- Those with a low-income. For many of these people, starting Social Security early while also working as much as practicable could well make sense.
- Wealthy people who might want to consider starting a foundation and using Social Security payments to fund it.
Author's note: The bullet list above was added post-publication.
There is no "penalty" for starting Social Security early. From an actuarial standpoint, an individual that starts Social Security at 62 would be expected to receive lifetime payments that are about the same as they would have been if they had retired later. This 27.5% reduction reflects receiving Social Security for a longer expected period and would not be a penalty for receiving Social Security early. Thus:
It is widely believed the benefit adjustments made for delaying Social Security benefits are actuarially fair. In other words, the average individual receives the same expected present value regardless of when benefits begin. Of course, even if the adjustments were actuarially fair for the population on average, they would not be actuarially fair for every individual. For example, those who expect to live longer than average can benefit from delaying, while those who expect to live shorter than average can benefit from claiming early." [Shoven and Slavov, 2012, NBER Working Paper 17866.]
There are a number of things to consider before deciding when to receive Social Security payments. Investors should do their own due diligence before deciding when to begin Social Security.
1. Financing Goals, Opportunity Cost, and Social Security
Investors can have a variety of investment goals, such as:
1. Maximizing investment returns commensurate with investment risk. The risk/return tradeoff is the key to investing. Investors must strike a balance between maximizing future returns and risk tolerance. Given the uncertainty and risk inherent to investing, this isn't an easy task.
2. Financial security. Maximizing wealth is also a potential investment goal, which can be considered in conjunction with risk/return tradeoff.
3. Living life to the fullest while maintaining a peace-of-mind "cushion." An investment goal might be to maintain a reasonable standard of living and quality of life during retirement. Given economic uncertainty and systemic risks that are hard to diversify away, there may also be a goal of maintaining a financial cushion to protect against severe and unexpected financial outcomes.
4. Other goals. Investors may have other financial goals, including planned wealth transfer between generations, philanthropy, and so on.
Economists talk about opportunity costs when analyzing and choosing between alternatives. Thus, if you decide to pursue "Plan A", you could analyze whether you would be better off than if you had decided to pursue "Plan B." Deciding when to start Social Security is one piece of the puzzle in achieving your financial goals.
For many Americans, Social Security and Medicare are important parts of navigating the retirement process in a way that supports the achievement of the investor's financial goals. If it's not a necessary part of achieving your financial goals, then consider setting up a foundation or finding a charity that you want to donate the money to.
2. Issues to Consider
While individual circumstances will vary, I would suggest that there are three primary issues to consider before deciding to start receiving Social Security benefits prior to the ordinary retirement age. These are:
1. Already retired or semi-retired? For many people that fit this profile, drawing Social Security at age 62 rather than at 66.5 may make sense. To do otherwise, would mean foregoing 48 months of Social Security payments (albeit at a reduced amount per month), which would not be fully recovered if the individual does not live to the expected actuarial life. Starting Social Security payments at 62 may also allow investors that are not fully employed to avoid "cannibalizing" investments to pay for the costs of living.
2. Is the cost of medical insurance prior to eligibility for Medicare at age 65 an important motivation to keep working? Many keep working because they need the money or want to keep active, but a significant segment of people between the ages of 62 and 65 continue working to avoid having to pay directly for medical insurance. For many of these people, it probably makes sense to wait until retirement to begin receiving Social Security payments.
Those that are between the ages of 62 and 66.5 that earn under $17,640 in 2019 can both work and receive Social Security without a reduction in their Social Security benefit amount. For those that make more than $17,640, there may be a reduction in the benefit amount, but this reduction is applicable only for the year in question. Earning more between 62 and 65 would help to increase your Social Security payments in later years even though you are already drawing on Social Security.
There are other cases where both working and receiving Social Security may make sense. Doing so may be a necessary and reasonable step for some people with low incomes that are between the ages of 62 and 66.5. Some care would be needed to weigh these issues - as always investors should do their own due diligence.
3. Do you think that you fit the actuarial norms? It would probably be a mistake for a 62-year-old to assume they won't live to the actuarial norm for your cohort. Some will live far beyond the actuarial norm, some will live shorter lives, but they all need to be well-prepared financially to live a long and full life. Nevertheless, it may be useful to understand the actuarial norms and the implications for those that may be at the "tails" of the survival curve distribution, i.e., those that may die young or that may live a very long life.
Employer-funded health insurance and the transition to Medicare
Medicare coverage is usually available for people when they turn 65 (it may be available earlier in some cases, as discussed here). For people that view employer-paid health insurance coverage as the major incentive to keep working, that incentive to not retire early would largely end once they can begin Medicare coverage.
The initial enrollment period for Medicare begins three months before the month that contains your 65th birthday and it continues for three months after that birthday. As a result, you have an initial seven-month period during which you can sign up for Medicare.
While the full retirement age for persons born in 1957 is 66.5, some people may choose to retire at 65 when they are eligible for Medicare. While Social Security payments are smaller when you start at 65 compared to what they would have been if you had started at 66.5, from an actuarial standpoint, the payments should be essentially the same for those that live to the actuarially expected age.
Expected actuarial life
A ctuarial life tables. The Social Security Administration (SSA) provides an actuarial life table that indicates the period life expectancy for men and women of a given age using 2014 mortality rates. For a 62-year-old man, the indicated life expectancy is 20.00 years. For a 62-year-old woman, the indicated life expectancy is 22.81 years.
One might think that a 67-year-old would have a life expectancy of 15 years (20.00 minus 5) for men and 17.81 years (22.81 minus 5) for women. But, no, that isn't how it works. Some of your cohorts will fall away over time, meaning that if you survive to age 67, the actuarial life expectancy would be higher than the actuarial life expectancy of a 62-year-old.
For a 67-year-old man or woman, the indicated life expectancy is 16.36 years for men or 18.76 years for women. This is because if you have already lived to 67, some of your cohorts have passed away, leaving you with an actuarial chance of an extra 1.36 or 0.95 years compared to a 62-year-old.
This may give you a bit better chance of being made whole for the opportunity cost of waiting to age 65 to receive Social Security than anticipated. The problem with all this is that much depends on what happens during the out-years of the period.
Information Sources
The SSA provides information and data that can help an individual or couple decide when to retire. The first step is to set up an ID and password so that you can access your personal retirement information.
Social Security has a number of calculators that you can use, depending on exactly what question you want to answer. These include:
1. "The full retirement age is the age at which a person may first become entitled to full or unreduced retirement benefits." The SSA provides information on the applicable full retirement age. For investors born in 1943-1954, the full retirement age is 66. For investors born between 1955 and 1960, the full retirement age begins at 66 1/6 for 1955, then increases to 66 1/3 for 1956, 66 1/2 for 1957, 66 3/4 for 1958, and 66 5/6 for 1959. For 1960 and later, the age is 67.
2. "If you start benefits early, your benefits are reduced a fraction of a percent for each month before your full retirement age." Given the changes in the full retirement age, care needs to be taken in identifying the adjustment rate for early retirement. The SSA explains this issue here. There is also a bonus for delaying retirement to ages 68 to 70. SSA provides a calculator where you can provide your birth date and target benefit date and then the effect of your retirement choice on your benefit rate is calculated. I would encourage anyone considering early retirement to use this calculator to determine your benefit percentage relative to the full retirement benefit.
Conclusion
Before studying the best time to begin social security for myself, I had assumed that there was a "penalty" for taking social security early. I planned to identify the discount rate that resulted in indifference between starting Social Security early or waiting and then would have considered how investors should evaluate that discount rate in light of their personal financial circumstances. However, I found that the discount rate to justify taking social security is low, which makes sense given that the Social Security system is set up so you can decide for yourself when you want to retire and be confident that you will be treated fairly in the sense that you will get about the same number of dollars as you would have if you had retired at the standard age of 66.5.
I was surprised to discover that there is no "penalty" for taking social security. Given actuarial life expectancies, a 62-year-old taking social security should collect about the same amount in social security as that individual would have done if they had waited to the full retirement age (or any age in between). Thus, an individual might delay taking Social Security because they are working and don't need the money, while another individual might decide to take social security at 62 because they don't have a full-time job and would have to deplete assets if they didn't take social security.
The beauty of this Social Security setup is that you can decide when to start Social Security based on your own financial goals and circumstances and be reasonably assured that you will be treated symmetrically compared to other Social Security recipients.
This article was written by
CFA, CPA, MA in Economics.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Source: https://seekingalpha.com/article/4244955-62-66_5-is-really-penalty-for-taking-social-security-early