Jacob: Your highest earning thirty five years of work is what's going to be factored into the calculation determining what your Social Security benefits will be. Welcome to Retirement Answers, a podcast built to answer your most pressing retirement questions. If you're someone who's either thinking about retirement or already in retirement, well, you're in the right place. Hey there, my name is Jacob Duke, and each week I'll be walking through different tips and strategies to help you succeed in retirement. So let's go ahead and get started with today's show.
Hey, everyone, and welcome back to another episode of Retirement Answers. My name is Jacob Duke. I'm a certified financial planner, and I enjoy helping people just like you retire all the time. Today, I wanted to talk about a very popular topic amongst retirees, and it's around the question of when do I need to take a Social Security and what are the pros or the cons of taking it early or delaying it into the future? So that's what we're gonna cover today.
But to do that, I wanna make sure we have a good understanding of how Social Security works, kind of how it's calculated, some different acronyms that we need to know about. We need know about full retirement ages and primary insurance amounts. And then I wanted to give you three different questions to ask yourself in terms of when you should be taking Social Security. But then also I want to give you six considerations to think about that might change your mind on when you should take your Social Security benefits. But before we get started, thank you so much for tuning into the show.
If you are a new listener, welcome to the show, and I'm glad that you have found me. If you are an active listener and you've been following along for a while, thank you so much for your support. And if you find this helpful, go ahead and share it with a friend that might also learn something from this. And then also give a rating and review there on the podcast platform that you are listening through. So thank you so much.
And let's go ahead and jump into today's episode. Okay, so Social Security benefits can be really confusing for a lot of people because you have these things called PIAs and FRAs and AIMES, all these different acronyms. So let's go ahead and break this down and really simplify it and keep it kind of surface level. We don't want to dive into all of the intricacies or details of how things are calculated, but it's important to know for your sake what goes into this. That way you can make an educated decision.
So the first thing to know is that your highest earning thirty five years of work is what's going to be factored into the calculation determining what your social security benefits will be. So the highest thirty five years, that means if you worked for longer than thirty five years and have wages for more than thirty five years, that means the highest thirty five years is what's gonna be factored in. If you worked less than thirty five years, well, only the amount of years that you actually worked will be factored in ultimately reducing your benefit amounts. But also we have to know that the average index monthly earnings amount, AIME is important as well because if you earned $20,000 in 1980, well, we have to index that for inflation to get to what that is in today's dollars. So don't think that you're gonna be penalized for having a lower income in the past.
We always have to index those for inflation to get those up to today's dollars. Now I'm not gonna go through the details of how that actually is calculated because that's just not important for today's conversation, but just know that they are indexed for inflation and they're added up, they're divided by the number of months and the amount of years that you actually worked, and that gives you your average indexed monthly earnings amount. From that point, then you can figure out your PIA, which stands for primary insurance amount, but it has to go through BIN points and kind of some different calculations. Again, not getting into that because it's not the most important thing to talk about right now, but your PIA, that is your primary insurance amount, which is your full benefit that you're entitled to at your FRA, which stands for full retirement age. So a lot of alphabet soup there, a lot of acronyms, but the two most important ones to know is FRA, which is full retirement age, and then also PIA, which is primary insurance amount.
Your primary insurance amount is what you're entitled to as your benefit at your full retirement age. But what is your full retirement age? A lot of people have this question, so I wanted to make sure I emphasize this and explain this. But in terms of figuring out your full retirement age, it's really based on the year in which you were born. So if you were born in 1960 or after, your full retirement age is gonna be age 67.
If you were born in 1954 or before that, your full retirement age is gonna be 66. And if you were born from '55 until '59, it's gonna be somewhere between 66 and 67. And here's how that would work. If you were born in 1955, that means that your full retirement age would be sixty six and two months. If you were born in '56, then it'll be sixty six and four months and so forth.
It would be increasing by two months for every year that you go up from 55 all the way to 59. So hope that makes sense. But today we're gonna just assume that the full retirement age for all the conversations we're gonna have today and just everything we're talking about is 67, just to keep it really simple. Now, why were you even having this conversation around when to take your Social Security benefits? Well, the reason is, is because every year or month that you delay your benefits into the future, you're going to be increasing your benefits.
So the earliest age that you can take your social security benefits is 62. That's regardless of what your full retirement age is. So let's say that you are full retirement age 67, but you take it at 62. Well, you're taking it five years early. That means that you're going to get a reduced benefit from what you're technically entitled to or what you technically paid into the system for.
And that could be reduced by up to 30%. So in dollar terms, if your full retirement age benefit is supposed to be $3,000 and you decide to take it at 62 and take it early, then you will be reduced by 30%, which in dollar terms comes out to be your benefit at 62 would now be $2,100 instead of $3,000 that you're entitled to at your full retirement age. So every year that you delay your benefits past 62, you're actually increasing your benefit by 8%. So if you take it at 63, that means that your benefit will be 8% larger than it was at 62. If you take it at 64, that means it's gonna be 8% larger than it was at 63 and so forth.
Now, sometimes people have the question of, do I have to delay this my the full year and actually get that 8% increase? And the answer is no, you don't have to delay it all the way from the day you turn 62 until the day you turn 63. The benefits are calculated based on every month that you delay. So if you retire at 62 and you delay your social security benefits from 62 until 62.5, that means that you would have six months of additional benefit credits that you would add on top of whatever you would have gotten at 62. So don't think you have to delay it the full year to get that annual increase.
Just know that it's actually a monthly calculation and you're not actually losing anything by taking it before a full year passes. So we all understand that whenever you take it at 62, we're getting reduced benefits. If we take it at 67, we're getting the benefits we should receive. And if we delay it all the way until 70, that's whenever we get additional benefits on top of whatever we paid into the system. Now don't delay it past 70 because there's no additional benefits.
By delaying it past 70, you would be capped out on what you're able to earn or grow your benefits too. So once you get to 70, it doesn't really make sense to delay it any farther. Just take it at that point. That way you can actually start getting your benefits. So the biggest question that most retirees face is, well, when do I actually start taking these social security benefits?
And there's a lot of different factors that go into this, but one of the most common phrases that I hear is that I'm just going to go ahead and take my benefits while I can, because who knows how long I'm going to live and I want to get at least what I can out of Social Security. And I totally understand that because that's our human nature. We want to get what we can, while we can. None of us are guaranteed tomorrow. Therefore, it's not a terrible idea to take it today, right?
Well, there are some different factors that go into that and we want to make sure we consider those. That's why I put together three questions that we need to think about and answer for ourselves before we go ahead and jump in and take it at 62. And then also in just a minute, I wanted to walk through six other considerations to think about whenever we're deciding when to take social security. So the first question you have to ask yourself is what is most important to you? Is it maximizing retirement income or is it leaving as much money as you can to your kids or grandkids or spouse one day?
Because I find that a lot of people prefer one more than another. Some people are focused primarily on securing their retirement income and ultimately maximizing it so they can enjoy as much money while they can while they're alive and leaving money to their kids or grandkids just isn't the biggest priority for them. Others though are way more focused on leaving a legacy for their family, their kids, their grandkids, because that is what they desire to do. Now, what does this actually look like in practice? Well, to maximize your income in retirement, it might make sense to delay your Social Security until 70.
That would give you the largest benefit while you're alive in terms of how much money you were receiving from Social Security. But it's important to factor in remember, you know, break evens and how long you have to live in order to make back what you've given up by delaying and everything that kind of comes into play there. But if you want to maximize your wealth transfer to your kids or grandkids one day, well, take your social security at 62 because that means that that's less amount of money you're gonna have to pull from your portfolio or your assets because you have a social security income to rely on. So it's kind of a one or the other in deciding which is most important to you, and this is what I call like a preference based decision. It's not necessarily a financial decision, it's it's what do you want to do for you or your family, it's less about how do I optimize the most money right now today for me or throughout the rest of my life, it's it's a preference on what's more important to you.
So if you want to have the most income in retirement, delay social security, at least until full retirement age. If you prefer to leave more money for your kids or grandkids one day, maybe go ahead and take that social security benefit now. So that means you would be pulling less from your accounts. The second question that you had to think about is, are you going to be working in any capacity after you retire? Now, many people end up with a part time job or continue doing some sort of consulting work after they retire and they do this to supplement their income.
But it's important to know that your benefit will only be reduced if you're taking your social security benefit and you're above the income limit and you're not yet to your full retirement age. So that means if you are at full retirement age or older, you can work, earn as much money as you would like, and also still receive your Social Security benefits and not have those benefits reduced. So what is the income limit before your Social Security benefits start to be reduced? Well, in 2023, it's $21,240. You can earn under that amount of money as earned income from a job and never have your Social Security benefits reduced if you're not yet to full retirement age.
Now, once you go over 21,240 of earned income for the year, that's whenever your Social Security benefits will be reduced by $1 for every $2 you earn above that limit. And to dig into this even further, in the year that you actually reach full retirement age, the deduction will go from $1 of benefits for every $3 you earn, and that benefit is no longer $21,240 it goes all the way up to 56,520. So in the year that you are actually getting to full retirement age, your benefits are reduced by $1 for every $3 you earn instead of $1 for every $2 you earn, and that income limit is increased from 21,240 all the way up to 56,520. So a couple of things to think about here in regards to whether or not you will be working or earning an income in retirement. Just know that if you are taking social security before full retirement age and you're earning an income, you will be subject to those income limits, which means that you could be reducing the amount of social security you will be receiving.
Now, it's also important to know that you're not giving up the amount that you're reducing it by forever. You get paid back those benefits in the future once you get to full retirement age, but in the meantime, you're not actually getting those benefits in your pocket. So it might make sense to actually delay your Social Security if you expect to have income in retirement, because two things are going to happen there. You may not need the income from your Social Security benefits because you're earning an income already, And if you delay it farther, that means that you're building a larger benefit for yourself and you're not having to take a reduced benefit while you're earning that income. The third question you might want to ask yourself when deciding when to take Social Security is, well, do you actually need those Social Security benefits right now?
You could have a pension or rental income that provides you a stable stream of income in retirement, or perhaps your portfolio is large enough and leaving a ton of money for your kids or grandkids one day is not your top priority. Therefore, you have plenty of assets to live on and produce income from, which ultimately gives you the opportunity to delay your Social Security benefits past 62 or even past full retirement age and build that benefit for you moving forward. Now, if you don't need your social security benefits right now, as soon as you retire, that is a huge luxury. Many Americans don't have that opportunity, which kind of makes me want to emphasize, hey, if you have that opportunity, you might wanna think about taking it because many people don't have the luxury of getting to choose. So that's the third question is, do you really need those benefits right now?
Or are you just gonna take them and reinvest them back in the market? Because if that's the plan, you might wanna think about delaying that into the future because every year that you delay your benefits past 62, you're increasing your benefit by 8%. Now that's a guaranteed increase, like you will get that increase in income amount in the future, as opposed to if you take that money out at 62 and start receiving your benefits and then immediately go reinvest that in your brokerage account, well, number one, you're gonna have to pay taxes on those social security benefits, assuming you have other income. And then number two, there's no way to get an 8% guaranteed return anywhere else in the market, right? So an 8% guaranteed increase on your benefits is really hard to pass up, especially when you don't need those benefits right away.
So those are the three kind of questions that I think you should be asking yourself that will help determine, do I need to take my social security benefits at 62 or before full retirement age, or am I able to delay until full retirement age or perhaps even age 70? Now, here are six other considerations to think about whenever you're trying to make this decision. The first one is that whenever we think about cost of living adjustments or COLA for short, have we to think about what is that COLA being applied to? So back in 2022, after we had this great inflation event over the past year, the cost of living adjustment for Social Security benefits in 2022 was 8.7%. Now that is one of the largest benefits ever.
And if we think about it, a large percentage increase in terms of the COLA on a larger dollar amount is actually more beneficial than on a smaller dollar amount. So for an example, let's assume that you were receiving $3,000 as your social security benefit in 2022, compared to if you were receiving a $2,000 benefit. Now 8.7% applied to each of those dollar amounts yields a different increase in terms of dollars. For the $3,000 benefit, if you have an 8.7% increase on that, that means that your benefit is now $261 higher and an 8.7% increase on the $2,000 benefit is only 174 higher. So you see that whenever we talk in percentages and dollar amounts, you're getting a greater cost of living adjustment whenever you have a larger social security benefit.
So that leads to the point of saying, well, if you delay past 62, let's say that at 62, your benefit would have been $2,000 per month versus at 67, it could be $3,000 a month. Well, that means moving forward, your cost of living adjustments will be on larger amounts, therefore yielding a larger cost of living adjustment in terms of dollars. So year after year, you're compounding at a larger rate than if you had a smaller benefit. So that's one consideration to think about. In the future as cost of living adjustments come to you and they're added to your social security benefits, the larger the benefit is when you start, that means that your cost of living adjustments will be that much more helpful or impactful for you because it'll be based on a larger primary insurance amount.
The second consideration to think about is spousal benefits. So most of us think of spousal benefits as the opportunity to get at least 50% of our spouse's primary insurance amount or our own, whichever is greater. So that's important to consider, right? Let's give an example of a couple where one spouse, the benefit is $3,000 a month and the other spouse is only $1,000 a month. Perhaps the second spouse maybe didn't work a full thirty five years or perhaps stayed home for a little while, just didn't have the earnings credits that the other spouse had.
Well, in that situation, the spouse with the smaller benefits is entitled to up to 50% of their spouse's primary insurance amount. But a couple of things have to be true. And I've done a couple episodes on this in the past, but in order to get that full 50% spousal benefit, whichever spouse has the lower of the two has to take their benefit at their full retirement age. If they decide to take it early, that means they won't be entitled to the full 50% of their spouse's benefit. They would have somewhere underneath that.
And let's say you take your own benefit at 62 and then you're still entitled to a portion of your spouse's benefit. Well, if you take it at 62, that means that you would reduce your opportunity from 50% of their primary insurance amount all the way down to 32 and a half percent. So whenever we're thinking about spousal benefits, if your benefit is way lower than your spouse's, it might make sense for you to delay your benefit until full retirement age. That way you can get the full 50% that's available to you of your spouse's benefit. So just something to think about.
And remember, this is based on primary insurance amount. It's not based on what your spouse is actually receiving. So this is a really important consideration, especially for those who have very unequal social security income benefit opportunities. The third consideration to think about here is survivor benefits because very much like the spousal benefit. If your spouse passes away, you are entitled to 100% of the benefit they were receiving at the time of their death or your own, whichever is greater.
So let's say we go back to that situation where one spouse has a much larger benefit than the other 3,000 for one and maybe a thousand dollars a month for the other. That means that it might make sense to kind do some planning here and say, well, what if the larger benefit, what we delay that even farther, make it as big as we possibly can, maybe delay it all the way till 70, and then that means that the surviving spouse, perhaps the wife is ten years younger than the husband and the husband has a larger benefit, let's say. Well, means that if you delay that as far as you can to age 70, build up that benefit as much as you can, then the wife who is much younger and likely to live long past her husband, she would be that much better off because now she would get a 100% of a larger benefit instead of where the husband could take his benefit at 62, reducing how much he gets while he's alive, but then also reducing how much his spouse would get whenever he passes away in the future. So thinking about what your spouse can get while you're both alive in terms of spouse benefits, but then also survivor benefits once one of you passes away really plays into the conversation of how you should plan for when and how you take your Social Security benefits.
The fourth consideration to think about here is all the different tax strategies that might be important to you. So for example, Roth conversions are often a big piece of many people's retirement plans, especially for those of you who have large tax deferred account balances in your IRAs and 401ks. Roth conversions are really good tax planning strategy, assuming you have the opportunity to do it. But when you take social security actually is going to play into this a lot. If you take social security at 62, well, that's cutting into how much income you have before you go into larger tax brackets.
So it might make sense if you're planning on doing Roth conversion strategies to ultimately lower that tax deferred balance, it might make sense for you to defer your social security benefits into the future while you're doing those Roth conversions because that allows you that much more room to do the conversions at the lowest tax rates being ten, twelve, 22 or 24%. As soon as you add social security to it, you get taxed in two extra ways while you're doing those raw conversions. Number one, you're obviously not gonna be able to do as much conversion at those lower tax brackets, but then also your social security income will now become taxable at least in part because of the conversion dollars that are gonna be added onto your tax bill. So you kind of feel the tax pressure of that on both sides because you're taking social security. So maybe delaying social security into the future whenever you're doing these different tax strategies like Roth conversions, it might be the best option for you and you're gonna continue building that benefit for yourself and your spouse in the future.
And then the fifth consideration really ties into that, but whenever we think about RMDs in the future, well, if you're going to have a really big tax bill because of required minimum distributions, then those tax strategies that I mentioned in point number four, like Roth conversions, they're going to become that much more important. So we have to think about RMDs and requirement of distributions when it comes to taxation in the future on the dollars that you're actually having to pull out of your IRAs and 401ks, but we also have to think about it from a Medicare standpoint because if you're earning too much money or have too much taxable income, that means that Irma might come into play, income related monthly adjustment amounts, and that could be a surcharge on your Medicare premiums, which is a lot of times unexpected or never really thought about whenever people do their retirement planning. So going back to point number four with your tax strategies, number five is RMDs and how those might affect you in the future. We have to think about that and how that actually plays into when we take social security and ultimately the taxation of our social security in the future because of those unexpected RMDs.
And the sixth consideration to think about is, can I live on other sources of income while I delay my social security benefits? And if you have the opportunity to delay your benefits and live on other sources of income, this is a, like I mentioned earlier, a great luxury to be able to have, and just the option to choose is a great benefit to you. So this is back to the conversation of what do you prefer? Do you prefer to have more money that you leave for your kids or grand kids one day? Or do you prefer to lock in and secure your retirement income and ultimately guarantee a higher income while you're alive?
So that's kind of a preference based question, but if you have other sources of income that really affords you the opportunity to delay, maybe you have a rental income, maybe you have a pension or something like that. So having those different sources of income affords you the opportunity to delay, and I think you should consider that whenever you're trying to figure out what the best options might be for you. So maybe this has kind of shown you that it's not always as easy as just saying to yourself, I'm gonna go ahead and take my benefits as soon as possible because I don't wanna miss out on something that I paid into because who knows how long I'm gonna be here. Yes, that is reality. Like you could pass away tomorrow and never receive any of your social security benefits because in a perfect world, if we knew when we would pass away, that would make this decision so much easier.
And it's just not reality, right? So all that we can do is just make the best decision for you and your family with the information that you have available to you at that time. And hopefully these different considerations that I've talked about today and the questions that I kind of presented to you, hopefully they can help you make a more educated decision around when to take your social security benefits because every year that you delay, remember you get an 8% increase from 62 all the way to 67, and then moving forward to up until age 70. And there's other tax considerations to think about whenever you're trying to decide, should I take my benefit now or not? So I hope this has been a helpful conversation for you as you evaluate your options around social security timing.
So if it has, feel free to give me a rating and review here on the podcast app that you're listening through, and if you have a friend that might benefit from this, feel free to share it with them as well so they can learn from this too. Thank you for tuning into this week's episode of Retirement Answers. I look forward to being right back here with you again next week. Hey, it's Jacob again, and I wanted to extend a quick offer to you. If you have a question and you would like to have it answered here on the show, please email me at jacobretirementanswers dot net.
And I'd love to answer that question for you right here on the show. Also, wanted to remind you that nothing discussed in today's episode is meant to be financial, legal or tax advice. Retirement Answers is for educational purposes only. Thanks for tuning into this week's episode. I look forward to talking with you again next week.