Potential Employment Income Between Age 62 and Full Retirement Age
As stated in Part 1, there are four factors that should be considered individually and collectively when making the decision regarding when to begin collecting Social Security benefits. This post will discuss how employment income affects the amount of one’s benefit between the age of 62 and full retirement age (“FRA”), i.e., 65 to 67, depending upon year of birth.
Let’s start with a simple example to begin illustrating some of the immediate consequences of pre-full retirement age (“FRA”) commencement of Social Security benefits. Suppose you were born between 1943 and 1954 and you’re eligible to start receiving a monthly benefit of $2,000 beginning at FRA age 66 and you instead elect to begin receiving your payment at age 62. This will result in a 25%, or $500, per month reduction of your benefit, resulting in a monthly payment of $1,500, or 75% of your FRA benefit of $2,000.
Per Exhibit 1, assuming you start receiving your benefit at age 62, while your annual benefit of $18,000 will be $6,000 less than your annual benefit of $24,000 if you instead wait until age 66, your cumulative benefits will be greater until age 77 at which time cumulative benefits of $288,000 would be identical. At age 92, age 66 commencement would result in cumulative benefits of $648,000, or $90,000 greater than the cumulative benefits of $558,000 assuming receipt beginning at age 62. The difference in cumulative benefits is further illustrated in the chart in Exhibit 2. Although there was no cost of living adjustment (“COLA”) in 2010 and Social Security Administration announced on Friday that there won’t be one for next year, actual annual and cumulative differences would be greater when taking into consideration COLA’s.
The amount of benefit reduction resulting from commencement of benefits at age 62 will be even greater if you’re working and your earnings exceed a specified limit. For 2010, each $1 in benefits otherwise payable at FRA will be reduced for each $2 that you earn above the limit which in 2010 is $14,160. Suppose in the previous example you earn $20,160 in 2010. Since this is $6,000 in excess of the limit ($20,160 – $14,160), your Social Security benefits will be reduced by $3,000 (1/2 x $6,000) per year, or $250 per month. Instead of receiving $1,500 per month, the amount will be further reduced to $1,250, or 62.5% of your FRA benefit of $2,000.
This work-related benefit reduction will continue until the year you reach your FRA. When this occurs, which in the example being used is age 66, each $1 in benefits will be reduced for each $3 you earn above a specified limit, which in 2010 is $37,680. This will continue until the month that you reach age 66 at which time the amount of your earnings will no longer affect your monthly payment. You can earn $200,000 per year from this point on and your monthly benefit would continue to be $1,500.
The pre-FRA employment penalty may not end up leaving a permanent scar on your future benefits. For one thing, Social Security Administration takes into consideration your highest 35 years of earnings when computing your benefits. If you either worked less than 35 years before collecting Social Security at age 62 or your earnings between age 62 and FRA were greater than other years included in the calculation of your benefits, your future Social Security benefits will be greater than what they would have been had you not worked between age 62 and FRA.
In addition, Social Security Administration gives you credit for each month that your benefits were reduced because you exceeded the earnings limit. Once you reach your FRA, your payments will be increased to reflect your credits. The longer you live, the more likely it is that you will recoup your pre-FRA reduced benefit attributable to working. Consequently, as a result of the foregoing two post-FRA calculation adjustments, the pre-FRA employment penalty may be totally negated.
Part 3 will discuss income tax consequences of flipping the Social Security switch before full retirement age.