Social Security and Early Retirement: Know Your Bend Points!
Social Security is something we aspiring early retirees don’t spend much time talking about.
While we may notice how much we’ve kicked in ($7,886.40 from me and $7,886.40 from my employer this year), we tend to largely ignore it when calculating safe withdrawal rates and our annual cashflow. If we mention it all, it’s usually with an asterisk because it’s so far off and somewhat uncertain.
In all likelihood, some money will be there. The calculations may be different than they are today, but that’s true anytime we make projections based on current tax code, and that’s something we do a lot.
Based on last year’s annual report from the Social Security Board of Trustees, the program is fully funded through 2034, and three quarters funded for the long term with many options to address the long term shortfall. Politics will play a role in deciding if that means decreased benefits, an older age at which they’re available, or an increase in the amount of salary subject to Social Security tax.
While we don’t know which way it will go, and it’s quite alright to plan as if it doesn’t exist (better safe than sorry), the reality is that Social Security will quite likely be a benefit to many of us in the latter portion of our early retirement (otherwise known as ordinary retirement).
Social Security and Early Retirement
There are some early retirees who should not plan on Social Security income. If you earned your money outside the U.S. and did not pay into the system, you’re out. If you failed to earn income for 10 years (40 three-month quarters of at least an inflation-adjusted $1,300 income), you’re not eligible. However, non-qualifying spouses married to someone who qualifies for Social Security can receive half their spouse’s benefit if taken at full retirement age (FRA).
If you are considering an early retirement, I would strongly encourage you to aim for at least ten years of contributions to the system. Note that these don’t all necessarily have to be completed prior to pulling the FIRE trigger. If not, you must plan on having at least some reportable income whether from a hobby job or self-employment of some kind until you’ve hit your forty eligible quarters.
Know the Social Security Bend Points!
What are these bend points? They’re the two points at which you receive diminishing returns in your monthly benefit once you’ve earned a certain amount of money.
The money you’ve contributed over the years is used to calculate your Average Indexed Monthly Earnings (AIME). It’s an inflation-adjusted average of your monthly earnings over your most lucrative 35 years. If you work and contribute for fewer than 35 years, zeroes fill in the blanks.
I’ll have a calculator for your AIME below, but essentially it’s your total inflation adjusted earnings divided by 420. What’s the significance of 420? In this case, it’s simply the number of months in 35 years. AIME is important in determining your monthly benefit when taking Social Security at full retirement age.
You get 90% of your AIME up to the first bend point (at an AIME of $885 in 2017)
You get 32% of your AIME between the first and second bend points ( portion of AIME between $885 and $5,336 in 2017)
You get 15% of your AIME beyond the second bend point (AIME above $5,336 in 2017)
For visual learners, let’s use my middle finger as an example. Might as well throw in a couple joints to accompany all this 420 talk.
The initial rate of rise is quite steep until you reach the first bend point (represented by my proximal interphalangeal joint). The slope is less steep between the first and second bend point (my distal interphalangeal joint), and it doesn’t rise all that much beyond the second bend point.
Clearly, building up your AIME to the first bend point at $885 is worthwhile. For every dollar up to $885, you’ll get 90 cents per month when you take Social Security at full retirement age (67 for those of us born after 1959). If you’re earning enough ($127,200 or more in 2017) to contribute the max to Social Security, you’ll hit the first bend point in a few short years.
Earning beyond the first bend point doesn’t do nearly as much for you, but you still get 32 cents for every dollar of AIME between the first bend point and the second at $5,336. Additional years of income between the bend points will make a noticeable difference in your eventual monthly benefit.
Once your Average Indexed Monthly Earnings reach the second bend point at $5,336, you’ll only receive 15 cents per dollar of AIME beyond that. Additional earnings give you vastly diminished returns at this level of AIME.
The bend points will increase annually with inflation, as will your AIME as older earnings will be worth more as time goes on.
Every time I create a new calculator, I learn some new spreadsheet tricks. This was perhaps the most labor-intensive one I’ve made thus far, but I think you’ll love it.
I’ve entered my information in the gray boxes, copied and pasted directly from the ssa.gov website. You can sign in or create an account here to access a lifetime record of your earnings. You can also find out what your anticipated monthly benefit (known as Primary Insurance Amount or PIA) will be if you continue to work at your current pace until age 67.
I’m assuming you probably won’t do that.
I’ve created a calculator that will tell you whether or not you’ve reached the first and second bend point and will estimate your monthly benefit if you were to stop contributing now. To extrapolate further, each additional year working and contributing the max will add about $303 ($127,200 / 420) to your AIME.
This calculator is accurate for those of us born after 1960. The benefits will be slightly higher for our friends born before JFK became president — see this table for adjustments here.
These are my numbers. I had some grocery store and self-employment income before I started making big money as a resident in 2002. From 2006 to 2017, I’ve earned and contributed the max for twelve years of maximum earnings. Just 23 more quick years, and I can collect the biggest check possible!
As you can see, with an AIME of nearly $4,000, I’ve easily surpassed the first bend point, but I’m just over $1,300 from the second bend point. Another year or two as an anesthesiologist and I’ll be getting closer, but in all likelihood, I’ll leave clinical medicine behind prior to reaching the second bend point.
If I continue to earn some income to reach that next bend point, that would be ideal, but at 32 cents on the dollar, I’m not all that concerned with growing my AIME. I’ll be even less enthused after that second bend point milestone is reached and an additional dollar of AIME is worth 15 cents in my monthly checks.
Calculate Your Social Security
I’ve created a page for you to enter your own numbers here on the 2017 Social Security Calculator, although it may be easier to simply download the calculator along with the rest of the calculators I’ve created for you. If you’re not a subscriber, sign up and you’ll receive a link. Subscribers, check the e-mail you received this morning for an updated link.
Our Plan for Social Security
Taking Social Security as soon as it’s available at age 62 results in a 30% penalty. I don’t like 30% penalties. That’s out.
At full retirement age, I get 100% of my calculated benefit. But each year that I hold off nets me an additional 8% per month for life. Unless I find myself in poor health, the smart money’s on the most money. I plan to delay my benefit until age 70.
Currently, doing so would give me about $26,000 a year, but with just a couple more years of max contributions, the AIME jumps by $600 and I’m looking at a benefit closer to $30,000 a year.
The max I could receive from an additional 21 years of work beyond that is about $43,000 per year according to the government website. That’s a gain of about $620 per year for each additional year worked. You’ve heard of golden handcuffs; these are papier-mâché handcuffs. Know your bend points!
My wife has done a lot of hard work, but most of it has gone unrecognized by the Social Security Administration. Obviously, the SSA has never had to clean up after me or my kids. But not all hope is lost.
As mentioned earlier, if she doesn’t qualify with 40 quarters, or if her benefit would be less than half of mine, she can file for Social Security at full retirement age and receive half of my FRA benefit as long as I’m around and my full benefit if I happen to leave this world before her. There is no benefit to postponing to age 70 for a spouse claiming spousal benefits.
Between the two of us, we will potentially receive checks that add up to about $40,000 a year in today’s dollars, which is about half of our anticipated retirement expenses. Granted, we’re about three decades away from that eventuality, but it never hurts to think ahead.
What’s your plan for Social Security? Have you passed the first bend point? The second? Let us know below!