What happens to your estimated SS benefits when you ER?

[Journeyman]

Understanding that more may change with SS benefits over the next 20+ years than remain the same, based on current calculations, can anyone explain how ER will impact your SS benefits?  For example, if in your 20's you averaged $50K for your taxed SS earnings and $100K in your 30's and then retire at 40 (assume at age 39 your estimated benefit for retirement age (67) is $2500/Month).  Once you retire at 40 you then only generate income from savings (dividends, etc) and do not pay SS Tax, how will that impact your SS benefit at "retirement" age (62/67/70)?
      
From the 2012 Social Security Statement:
      "...we estimated your benefit amounts using your average earnings over your working lifetime. For 2012 and later (up to retirement age), we assumed you'll continue to work and make about the same as you did in 2010 or 2011."
      
      Based on this, if you do not pay SS tax during ER, would your estimated benefits be frozen from 40 to 62 or would the SS administration start to average in zeros and dramatically reduce your benefit?  Returning to the example, if at 39 your estimated monthly benefit is $2500/Month but you no longer pay SS tax from 40 to 67, can you still expect to be in the $2500 ballpark (adjusting for inflation)?
      
      As an additional question, what if in ER you do earn a small income from your own endeavors (say $10K/year) and pay SS tax on the 10K, does that help or hurt your SS benefits.  Basically, are you better off not paying any SS Tax in ER or pay some on a much lower earnings base vs. when you were building your stash?
      
      Again, this is based on current SS calculations/benefits and I fully understand (and anticipate) quite a bit will change in the next 20+ years, but am curious how things would play out given today's rules.

[sol]

can anyone explain how ER will impact your SS benefits?

I've put a fair bit of thought into this question and yet I still don't have a solid answer.

Basically, your SS benefit is based on your highest 35 years of earnings, indexed backwards in time for inflation.  That means you can't really make any predictions about future dollar amounts without knowing future inflation rates. 

The bad: with far less than 35 years of wages, your 35-year average is going to be very small.

The good:  SS benefits are indexed for inflation to the year that you earned them, so unlike a pension they effectively go up every year between when you quit working and when you start collecting them.

There's no easy way to work this out.  One method is to assume future inflation will match past inflation patterns (a bad guess, due to the 70s) and use one of the online SS benefit calculators assuming that your first year of wages, say 2003, was actually 35 years before you retire; so if you plan to retire in 2020 then you would input your 2003 wages as 1985 wages.  Of course, you have to use a separate web calculator to reduce your 2003 wages to their 1985 inflation-adjusted value, making this whole process kind of messy. 

The easier route is just to look at your annual SS benefit statements over time, plot the value of benefit they predict if you were to quit working immediately (not the value they predict if you work til retirement age), and extrapolate out to your retirement date.  The year that you actually retire, it should be pretty close, again ignoring future variable inflation rates.

      As an additional question, what if in ER you do earn a small income from your own endeavors (say $10K/year) and pay SS tax on the 10K, does that help or hurt your SS benefits.  Basically, are you better off not paying any SS Tax in ER or pay some on a much lower earnings base vs. when you were building your stash?

It can't ever hurt you.  Your benefit is based on your highest earning 35 years, and many of those are likely to be zeros.  Any year that is above zero will raise your benefit.  Note, however, that earnings later in your life have a relatively smaller impact on your SS benefit than earnings early in life.

[MooreBonds]

can anyone explain how ER will impact your SS benefits?

Basically, your SS benefit is based on your highest 35 years of earnings, indexed backwards in time for inflation.  That means you can't really make any predictions about future dollar amounts without knowing future inflation rates. 

The bad: with far less than 35 years of wages, your 35-year average is going to be very small.

Slight modification: before you claim SS benefits, your wage record is indexed to the Average Wage Index, NOT to the CPI.
http://www.ssa.gov/OP_Home/cfr20/404/404-0211.htm

AFTER you start collecting SS benefits, then your benefits are adjusted based on the CPI. Also, while having a string of "$0" annual salaries will reduce your SS benefits....it might not impact it as much as one might fear.

There's no easy way to work this out.  One method is to assume future inflation will match past inflation patterns (a bad guess, due to the 70s) and use one of the online SS benefit calculators assuming that your first year of wages, say 2003, was actually 35 years before you retire; so if you plan to retire in 2020 then you would input your 2003 wages as 1985 wages.  Of course, you have to use a separate web calculator to reduce your 2003 wages to their 1985 inflation-adjusted value, making this whole process kind of messy. 

You can sign up for on-line access to your SS account to have your complete history of SS earnings. You can then enter that in the SS website that allows you to input your entire salary history to estimate your benefit. You can then enter salaries for future years before retirement, and see what your guesstimated benefit would be, and then compare that to if you worked until 60 or 65.

[JJ]

Over in Oz they keep messing with the rules for superannuation (retirement savings) and social security/pension.  My base assumption is that it won't be there when I get there (25 years away) so anything above zero is a nice bonus.  One of my favourite posts on the blog is the margins of safety (http://www.mrmoneymustache.com/2011/10/17/its-all-about-the-safety-margin/).  Social Security is safety net #5 for MMM - about the same spot for me.  Sorry - I know I haven't answered your question, but just pointing out that from my simpleton perspective it seems less relevant for ER than decreasing expenses and increasing savings rate.

[menorman]

Social Security? I'm not planning to see it at all, and it quite honestly needs to be pared back quite a bit anyway. It was originally supposed to be only a supplement, but it is now quite a cash cow that will have to receive some attention. Those who have the funds available really don't need to receive anything at all. Additionally, someone who's been living for 20+ years w/o it should really be quite used to not having it available.

[sowantere]

Ditto to the above.  I just see social security as a bonus if it presents itself.  I'm not going to work any extra just to up my average.  I think it would be better to plan without out it if possible if again only to be self sufficient.  As seeing how some people reacted with the recent Wall Street protests over the couple of years by being afraid of losing their retirements I would hate to see peoples votes swayed by fear of loss of social security.  I do respect the authors asking of the math behind the calculation of social security.

[tannybrown]

I can appreciate viewing SS purely as a bonus but, to the degree that one can accurately calculate future SS earnings, FI could be actually be achieved earlier.

[James81]

It's actually a good thing when you aren't throwing money into SS. SS benefits are a FANTASTIC waste of your money. So, the more money you can actually keep OUT of SS, the better off you are going to be.

If I had my way, I'd opt completely out of SS.

[sol]

It's actually a good thing when you aren't throwing money into SS. SS benefits are a FANTASTIC waste of your money.

I'm interested to hear why you think this?

If the real returns on your SS contributions are low, then isn't the government getting a sweet deal out of SS payments?  If that were the case, then I think we'd hear less about how SS is this terrible burden that is ruining the federal budget.

SS payments are regressively indexed to your salary.  This means that for someone earning more than the cap of $110k/year, SS is indeed a waste of money, at least compared to other uses of your money. 

For people at the lower end of the scale, however, I think SS is a great investment.  Where else can you get a guaranteed 100+% replacement rate of your pre-retirement salary for only 6.2% of your salary over 35 years?  Doing the math on this, 35 years of 6.2% contributions would generate 25x your annual salary (calculated assuming the standard 4% SWR) only if it earns an average of 11.4% per year.

How is a guaranteed 11.4%/year ROI a bad deal? 

That only applies to people in the lowest quintile of wage earners, of course, and the effective ROI will be smaller for people who earn more money.  Everyone in the US, though is basically guaranteed a government benefit equal to the lowest quintile of earners at great investment rates, even if they then go on to earn more money (or work more years) to increase their SS benefit.

Is there another reason why you think SS is a waste of money?

[velocistar237]

Here's a benefits estimator you can fiddle with:
http://www.ssa.gov/oact/quickcalc/index.html

You can put in your date of birth, current earnings, and projected retirement date, and get back your estimated benefit. The calculator assumes that your wages don't increase after the current year.

For example, for someone born in 1982 earning $80K now,

Retirement age	Monthly benefit at age 62 (today's dollars)
30	$666
35	$881
40	$1096
45	$1310
50	$1435
55	$1529

I didn't look at it closely, but it doesn't look linear. If you start working at age 22, then 8 years of work gets you $666, while 33 years of work gets you $1529. There might be a sweet spot somewhere in there.

[MrSaturday]

I didn't look at it closely, but it doesn't look linear. If you start working at age 22, then 8 years of work gets you $666, while 33 years of work gets you $1529. There might be a sweet spot somewhere in there.

Benefits are on a regressive scale.  The first $767 of your average monthly income is worth 90% for determining your SS benefits.  From $767 to $4624 those dollars are only worth 32%.  After $4264 the benefits are only worth 15% of extra wages.

See here for a detailed worksheet you can use to check the numbers manually.

Where else can you get a guaranteed 100+% replacement rate of your pre-retirement salary for only 6.2% of your salary over 35 years?

People on the low end of the scale get 90% of their inflation-adjusted average of the last 35 years.  Where do you get 100%+?

[sol]

People on the low end of the scale get 90% of their inflation-adjusted average of the last 35 years.  Where do you get 100%+?

By comparing the benefit at age 62 to your total income the year before retirement.  Because the benefit is indexed to wage inflation backwards in time and then receives favorable tax treatment, it's not so hard to end making more on SS than you made while working if you never made very much money.

Google social security replacement income and read all about it, but fair warning it's a complicated topic.

[velocistar237]

It looks like an early retiree gets a lot more benefit from their own dollars saved than from Social Security. For example, if you keep working after FI and save $45K after tax in one year, then that's another $150/month at a 4% SWR starting immediately, but it's only about $50/month more of social security starting at age 62 or 66. Social Security earnings should be a very minor factor in planning for ER.

See here for a detailed worksheet you can use to check the numbers manually.

Thanks for the link. Step 3 of that worksheet says to "Choose from Column D the 35 years with the highest amounts. Add these amounts." Earning a small amount after FI won't hurt SS benefits, to answer one of the OP's questions, because low earnings after FI can't decrease the highest 35 amounts. They can only help.

A self-employed person who has high earnings when they're young, followed by a long period with no earnings, gets an IRR (real return) of 2% to 3%. A self-employed person who works a full career at a well-paying job gets about 1.5% to 2.5%. Not that great, especially considering the possibility of future benefit changes.

The benefits calculation doesn't account for the time value of money, so if you want a good return on your SS taxes, start working later in life. At the extreme, if you earn nothing before age 62, and then earn $106K for three years, your annual SS benefit would be $8K, for a return of 20%.

Spreadsheet attached. I made it in Excel, and I don't know whether it works in LibreOffice. It makes some simplifying assumptions. Edits welcome.