How Social Security Pays You to Work Forever
Our Social Security expert, Larry Kotlikoff, explains why it's a smart financial move to put off retirement as long as possible in order to maximize your Social Security benefits.
Photo by Flickr user 401(K) 2013.
Larry Kotlikoff's Social Security original 34 "secrets", his additional secrets, his Social Security "mistakes" and his Social Security gotchas have prompted so many of you to write in that we now feature "Ask Larry" every Monday. This column is something a little bit different. Kotlikoff's state-of-the-art retirement software is available here, for free, in its "basic" version. His other substantial and often helpful output can be accessed at his website.
Larry Kotlikoff: I just turned 62, but feel 42 and, according to my kids, I act like I'm 12. I have a great job, perhaps the best job in the world. I'm an economics professor and get to teach, consult, write, advise governments, and run my personal finance software company. Each of these "jobs" is more fun than the next.
For me, "retirement," would be rough. I'd have to work very hard to find things as entertaining as my current jobs to occupy my time.
I realize I'm extraordinarily lucky. Simply being employed is a big deal these days. Having a guaranteed job due to tenure is lavish luxury. Being healthy enough to work late in life is another huge gift. And, the icing of doing something you love? Well, it's on the cake.
How long do I intend to "work"? Hopefully, right up to my last day on earth. And, as if I didn't have enough good reasons to work, Social Security, it turns out, adds a significant incentive for doing so. The longer you work, the larger your Social Security benefits. This is due to Social Security's "Recomputation of Benefits" provision. Here's how it works -- for all of us older cowpokes who remain in the saddle indefinitely.
Each year you work, you add to your earnings record, leading Social Security to automatically recalculate your benefits. If you are interested, here are the gory details.
In a nutshell, Social Security averages your highest 35 years of earnings to calculate your Average Indexed Monthly Earnings or AIME. Then it plugs your AIME into a formula that figures out your full retirement benefit, called your Primary Insurance Amount (PIA). What benefits you can get for yourself and your spouse (including your ex-spouse(s) and your children, if they are young enough or are disabled) is all pegged to your PIA.
From age 16 on, Social Security considers all your earnings, up to a ceiling that rises from year to year. It then indexes, based on historic wage growth, all earnings through the year you turn 60.
In other words, Social Security adjusts past earnings upward to account for the growth in the economy. But after age 60, you get credit for your earnings without any adjustment at all. So imagine that there's a sudden surge in inflation and wages after age 60 skyrocket. They're going to look spectacular compared to your wages of the past, even though they've been indexed. And here's the kicker. Social Security bases your benefits on your highest 35 years of earnings.
So now imagine that age 30 was the lowest of those 35 years and you made, say, $40,000, even after indexing. But now inflation takes off and you're suddenly making $200,000, even though $200,000 ain't what it used to be.
But for your Social Security benefits, this is a bonanza. You're suddenly being treated as if you were really earning a lot more, and thus deserving of much higher benefits. So, for every year that your post-60 earnings exceed the lowest of the previous 35 years, bingo! You'll raise your Social Security check (or checks, if your dependents are also collecting).
Is this a big deal? It certainly can be. Take my own situation. I didn't really start contributing much to Social Security until I was 29. I was in grad school before then and on a postdoctoral fellowship after grad school. If I were to stop working today and wait until 70 to collect benefits -- when they would start at their highest value -- my lifetime benefits would be $774,210. (Lifetime benefits are calculated as the present value of benefits through age 100 discounted at a 3 percent rate above inflation.) If I were to work until age 70, my lifetime benefits rise by $80,312 to $854,522. If I work till 80, they rise another $88,154 to $942,676.
Wow! Working to age 80 will raise my lifetime Social Security benefits by 22 percent! And this only has to do with the "Recomputation of Benefits," because in each scenario, I'm waiting to collect my retirement benefit until 70 and taking full advantage of the Delayed Retirement Credit (DRC) that increases your benefits if you start them after your initial full retirement age, which is 66 years old these days. (There is no additional DRC once you reach age 70.)
But that's not all! There's another kicker, namely spousal benefits. Let's suppose I were married to someone my age who had never worked. In this case, her lifetime spousal benefits would rise from $345,586 to $413,570 were I to work till 80. So in addition to picking up $168,466 for myself by working through age 80, I earn an extra $67,984 for my spouse.
In my case, just working through age 70 will kick out all the low-earnings ages from my Social Security record. But what I found remarkable, until I thought about it, was that working from 70 to 80 would generate an even larger increase in lifetime benefits.
The reason is that I'm above Social Security's earnings ceiling -- the income level at which a person no longer pays any further payroll tax. The ceiling was $106,800 in 2011, when I turned 60. Last year, it was $110,100, and this year it rises to $113,700. Extrapolating this roughly 3 percent annual growth rate, the earnings ceiling when I'm 79 will be close to $200,000!
Since all my earnings will be above the ceiling and all future earnings ceilings will exceed $106,800, each year I work will lead to a replacement of a lower earnings year in my AIME formula with a higher one.
Since the adjustment of the earnings ceiling depends on nominal wage growth, if inflation takes off or if real wages grow even more rapidly, the covered earnings ceiling will grow at an even faster pace.
And the fact that this nominal (face value) earnings is being compared with my earnings up through 60, albeit indexed by wage growth through age 60, means that I and everyone else in my boat that earns above the ceiling can benefit, potentially big time, from working very late in life.
I realize this is complex, but the essence of what's going on is that the AIME formula doesn't properly adjust for inflation and this failure to do so confers a Social Security benefit advantage to people like me who will continue to work. But even people earning below the ceiling are likely to benefit, especially if their current earnings are relatively high and grow relatively rapidly in the future.
The bottom line? If work is fun or at least not awful, keep at it, like the seniors in Paul's recent piece on the Vita Needle company; average age, 74! Or check out the recent Marketplace segment on "the retireless". Retirement can be awfully dull, and there is no guarantee that the grim reaper will make it on time. The bonus: for those who can keep working, Social Security may make it well worth your while.