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Is It Always Worth Working Longer to Maximize Your Social Security?

Posted by The Savvy Retiree on October 31, 2019 in Personal Finances, Social Security

When it comes to maximizing your Social Security, the general guidelines are to work for at least 35 years, earn as much money as you can, work until full retirement age, and delay your claim until age 70. In other words, work hard for as long as possible.

This isn’t necessarily bad advice. However, its simplicity can be misleading. The expectation is that each and every year you work and are subject to payroll tax is as important as the last, that your payroll contributions at the end of your career are worth as much as at the start. But the truth is a little more complicated, and, as always, depends entirely on your personal situation.

There are individuals for whom the payroll tax they pay in a particular year will be more than they ever get back from the nominal increase to their Social Security payments. There are also circumstances in which a few extra years’ work towards the end of retirement can make a huge difference in the Social Security you receive.

To know when you should continue working for the sake of Social Security and when it wouldn’t make that much difference, it’s essential to understand how your Social Security is calculated.

The Social Security Administration (SSA) calculates your eventual benefit based on 35 years of earnings history on which payroll taxes (or Social Security taxes) are paid.

While there is no simple formula for making a quick “guestimate” of the effect of stopping work early, there is a straightforward and far more accurate way to estimate the impact on your future benefit if you stop earning (or reduce the earnings) for some period before you start to collect your benefits.

Go to the official SSA Estimator and follow the instructions until you arrive at a screen presenting your Social Security statement. Now, click on the gray button below this estimate that says, “Add a new estimate.” You can use this option to change, or zero out, your earning by calendar year, making it possible to see what your Social Security benefit looks like if you were to stop working.

If you’ve contributed a few decades of Social Security tax, you might be surprised to find how little your benefits are reduced when even a large number of years of earnings are eliminated.

Why such little effect?

The formula used to compute your benefits is steeply progressive. That is to say, early in our working careers the additional year’s contributing have an enormous impact on our benefit amount; the impact declines steadily as we work longer, paying in more.

To put it another way, for most of us with relatively full working careers, the extra earnings from those last years of work will never be enough to cover the extra payroll taxes we will pay in.

However, there are situations where just a few years of earning before retirement could amount to a significant Social Security increase. This is especially true for people who, for whatever reason, have a more limited earnings history. These could include those who spent a substantial amount of time outside the regular work force, with homemakers being a case in point, as well as those who had income that was “off the books,” so Social Security taxes were not withheld and paid into the system.

Consider Carol, who has a grown daughter, Beth, from a marriage that lasted only a few years. She spent her life raising Beth, who lives with her and who eventually started a business out of Carol’s home. As the business grew, Carol helped out with the operation so Beth could focus on the growth.

Along the way some financial/tax advisor suggested concentrating the salary in Beth’s name. That was fine with Carol; she was just happy to help out her daughter. However, because Carol wasn’t contributing any payroll tax, this left her with no chance to collect a Social Security benefit based on her work record, even though she was approaching retirement age.

Now, suppose Beth decides to start paying Carol for her work at $3,000 a month, reducing her own salary accordingly. Together they would be paying a combined $4,500 yearly in payroll tax. This is the same Beth would be paying if she was the sole income earner, assuming she was under the earnings limit for Social Security tax. However, now Carol is also eligible to receive Social Security.

After 10 years—and $45,000 of payroll taxes—Carol now qualifies for an age 70 benefit of $1,078 a month, or about $13,000 per year. One way to look at it is as a 29% yearly rate of return, adjusted for inflation, on the original investment (of taxes paid) for as long as Carol lives. Or, since Carol’s typical life expectancy is another 17+ years after she turns 70, she can anticipate collecting over $220,000, guaranteed by the government (probably without taxes since most Social Security benefits are tax free) because of a $45,000 investment. And of course, the longer Carol lives, the more it pays.

Keep in mind that this rejuggling of the incomes will have negligible effect on Beth’s eventual benefits. As we saw above, it is largely set once we have many years of earnings. Yet the difference this could make for Carol in her retirement could make all the difference for her financial security. If you’re in you late 40s or 50s and haven’t worked enough to qualify for a benefit on your own record, it would pay off well in Social Security income to reach the qualification threshold.

If you have only a few more quarters to go, even reaching the minimum earnings of $1,320 per quarter would make all the difference.

Written by Steve Garfink