SOCIAL SECURITY’S complexity never fails to surprise. While many retirees have some sense for what factors determine the size of their Social Security check, few appreciate just how involved the benefits calculation can be.
For example, have you ever wondered what the Social Security Administration does if you continue working after starting benefits? It’s not a simple answer. There are two distinct treatments depending on whether you start benefits before or after you reach your full Social Security retirement age, which is age 66 or 67, depending on the year you were born.
If you start collecting Social Security prior to reaching your full retirement age, any employment income is subject to an earnings test and could cause a benefit reduction. The earnings test threshold in 2022 is $19,560. The government reduces your benefit by one dollar for every two dollars you earn above that amount.
The reduction becomes much less severe in the year you reach your full retirement age. You lose one dollar for every three dollars earned above $51,960. The benefits that were withheld prior to full retirement age aren’t necessarily lost forever. Once you reach your full retirement age, your monthly benefit is adjusted upward to reflect the benefits surrendered over the prior years. And at that point, you can earn as much as you want, with no reduction in your Social Security benefit.
The complexity doesn’t stop there. In some cases, additional work can actually raise the Social Security benefit you receive.
I recently spoke with a neighbor who was in this position. He had been advised to file for Social Security at his full retirement age of 66, even though he planned to work longer. This strategy might not make sense at first. He didn’t need his Social Security check to cover his living expenses, so why not wait? Delaying to 70, after all, would increase his benefit about 32%.
His financial advisor noted, however, that his additional years of earned income beyond age 66 could raise his Social Security payout, thus helping to offset the reduction from claiming before age 70. I was skeptical until I worked through the math myself and researched how the government calculates Social Security benefits.
The first number the Social Security Administration uses to calculate your retirement benefit is your lifetime earnings total. They add up all of the money you made during the 35 highest-earning years of your career, adjust that sum for inflation, and then divide it by 420.
This calculation results in your average indexed monthly earnings, which you can think of as your inflation-adjusted average monthly wage. The government uses this number to determine your primary insurance amount, which is the benefit you receive if you file at your full retirement age.
So how can extra work raise benefits? If one of your working years after claiming benefits is one of your 35 highest, it would replace one of your lower-earning years and raise your overall average. If your additional year of income doesn’t crack your top 35, it wouldn’t affect your Social Security benefit.
The folks at the Social Security Administration take additional earning years into account through an automatic process called recomputation. This process usually occurs in the fall and the recomputed amount typically takes effect the following January. Recomputation cannot lower someone’s existing benefit.
If you enjoy complex calculations, financial planning expert Michael Kitces has an excellent article on how your average indexed monthly earnings and primary insurance amount are calculated. You can use this information to see if your benefits would increase with an additional year of work. You can also do the math on the Social Security website.
Here’s how: Log into your “my Social Security” account. While there, check your earnings record to see if there are any lower earnings years you can easily replace. Then scroll down to the “Plan For Retirement” tool and select the option to incorporate future yearly earnings. By running estimates with and without potential future earnings, you can see the impact of additional years of work.
I ran the analysis for myself, looking at claiming benefits at three different ages. For context, I was age 64 and eight months when I went through this exercise. In my first test, I started benefits on Jan. 1, 2023. If I earned the maximum taxable amount of $147,000 in 2022, my benefit would be $33 per month greater than if I earned nothing.
I then tested starting benefits at my full retirement age of 66 and 6 months. If I earned the maximum taxable amount until then, my benefit would be $69 per month greater than if I earned no income. This may not sound like a lot, but it amounts to $828 per year for the rest of my life.
Finally, I tested starting benefits at age 70. If I earned the maximum taxable amount to that point, my benefit would be greater by $174 per month, or $2,088 per year.
The upshot: Additional years of work in your 60s do indeed have the potential to improve your Social Security benefits if you have fewer than 35 working years or if you have any low income years in your earnings total. Still, the decision of when to claim benefits carries much more weight.
For instance, by delaying Social Security to age 70, I could increase my benefit by $896 per month, or $10,752 per year, compared to claiming at my full retirement age. That decision cannot be made in a vacuum, however. It would take me 14 years at the higher benefit amount to offset the benefits I would forgo between my full retirement age and age 70. If I am confident that I’ll live that long, delaying benefits might make sense. If I am not as confident about my health, it may be better to claim benefits sooner.
Richard Connor is a semi-retired aerospace engineer with a keen interest in finance.