I’ve written before (and expect to write more) about the Social Security Administration, which is both the primary source of disability insurance for low-income workers and one of the lowest-cost guaranteed retirement savings vehicles available to all workers in the United States.
I want to address a few curious issues that arise with late-career Social Security contributions, since for a variety of reasons they’re handled somewhat differently than the contributions you make throughout most of your working life.
Delaying retirement versus delaying Social Security benefits
First I need to untangle two slightly different questions. In my experience personal finance journalism focuses primarily on the benefits of delaying claiming Social Security benefits. The numbers differ very slightly depending on your birth year, but the general principle is that if you claim Social Security retirement benefits prior to your full retirement age your retirement benefit (what I calculated in this post) is reduced according to the following formula:
“a benefit is reduced 5/9 of one percent for each month before normal retirement age, up to 36 months. If the number of months exceeds 36, then the benefit is further reduced 5/12 of one percent per month.”
Meanwhile if you wait to claim until after your full retirement age your retirement benefit is increased by 8% per year you delay initiating your benefit.
That’s not what I’m talking about. As opposed to delaying claiming Social Security retirement benefits, I want to address issues arising from delaying retirement, which is to say continuing to contribute to Social Security in the last decade or so of your working life.
If you have reported earnings in fewer than 35 years, continuing to work will increase your benefit
Social Security retirement benefits are calculated based on your highest-earning 35 years, including years in which you earned nothing, so the addition of earnings up to 35 years will always increase your retirement benefit since it reduces the number of zeroes dragging down your average earnings.
For very-low-income workers there is a minimum retirement benefit, but very few workers both qualify for retirement benefits and are eligible for only the minimum benefit so I’ll set that special case aside for now.
If you have reported earnings in 35 or more years, continuing to work may or may not increase your benefit
One of the most important things to know about how Social Security benefits are calculated is that they’re on the basis of your wage-inflation-adjusted earnings. While up to $118,500 in 2016 earnings are subject to Social Security taxes, that’s the inflation-adjusted (according to their calculations) value of just $39,600 in 1985 earnings (to pick the year of my birth at random).
There’s a natural intuition that late-career workers earn more money than early-career workers, and so their increased earnings should increase their average 35-year earnings and drag up their retirement benefit.
But that is only true if their increased earnings outpaced the Social Security Administration’s wage-inflation gauge.
Now, obviously many people do, in fact, earn higher inflation-adjusted wages later in life than they do earlier in life, due to experience and seniority if nothing else. The key point here is that continuing to work after receiving 35 years of credit only increases your benefit according to the inflation-adjusted difference in your income.
Suppose a late-career worker with 35 years of credited income and whose income is above the taxable maximum of $118,500 has 1985 earnings not of $39,600 but instead half that, just $19,800. Using Social Security’s inflation adjustment, that works out to $56,628 in 2015 dollars. An additional year of crediting $118,500 in earnings to Social Security will definitely increase the worker’s retirement benefit, but by a fairly modest amount. To calculate it, deduct the annuity purchased by the $56,628 “rolled off” the worker’s earning history and add back the annuity purchased by the $118,500 added to the worker’s earning history (this exercise is left to the reader).
If you like your Social Security retirement benefit, you can keep it
Obviously most people treat their Social Security retirement benefit as something that happens to them. You work all your life, then you decide whether to start claiming at 62, at your full retirement age, or at age 70.
But late-career people who have already accumulated 35 years of Social Security earnings credit have other choices. They can keep working in their current profession and, if their wage-inflation-adjusted income is higher than their lowest lifetime earning year, marginally increase their retirement benefit.
Or they can do something else. This blog is independently financed, with an emphasis on independence. If your domestic labor income isn’t earning you a higher old-age pension, maybe you should consider something else. Start a business, travel, make a difference in the world. Your Social Security benefits will be waiting for you.