Early Retirement Will Impact Your Social Security Benefit

If you don’t pay into the system for at least 35 years, your payouts will be smaller.


Many people strive to retire early. But retiring early could reduce your Social Security benefits, which means you have to save even more on your own. Here’s how early retirement impacts your Social Security payments, even if you delay receiving benefits until the full retirement age of 67.

Eligibility. You need 40 credits of work in order to receive Social Security benefits. For 2012, you can earn one credit for every $1,130 you earn, up to a maximum of four credits each year. If you worked for at least 10 years and paid Social Security taxes, then you probably will be eligible for Social Security.

Average earnings. Social Security payouts are typically calculated using your average indexed monthly earnings (AIME). This calculation involves adjusting (or indexing) your entire earnings history to reflect changes in wage levels and the standard of living throughout your career. Then your 35 highest earning years will be totaled and averaged out to a monthly earning.

Payouts. Your AIME is then used to calculate your primary insurance amount (PIA), which is the amount you will get if you claim Social Security at your full retirement age. For 2012, your PIA is the sum of:

 (a) 90 percent of the first $767 of your AIME, plus

 (b) 32 percent of your AIME over $767 and through $4,624, plus

 (c) 15 percent of your AIME over $4,624.

However, these amounts may change in future years. And benefit payouts are decreased if you claim before your full retirement age, and can be increased if you delay claiming up until age 70.

Early retirement can impact this formula in a couple of important ways. If you retire significantly early, you will most likely stop working during your peak earning years. This will reduce your average earnings and, consequently, your Social Security benefit. And if you retire with less than 35 earning years, Social Security will average in zeros for those years.

For example, if you retire at age 52 after working for 30 years, your average earnings will be computed with 30 years of earnings plus 5 years of not earning. This will bring down your average earnings and reduce your Social Security benefit. This Social Security online calculator will allow you to see exactly how early retirement will affect your benefit.

Early retirement could significantly reduce your Social Security payments. If you will be depending on that benefit, it could be more prudent to retire later and increase your average earnings. However, health problems or organizational cutbacks force early retirement on many people. In this case, even a part time job can help increase your Social Security checks later on, especially if it prevents zeros from dragging down your average earnings. If you plan to retire early, make sure you have enough in your retirement accounts to make up for your smaller Social Security checks.

Joe Udo is planning an exit strategy from his corporate job by reducing expenses and increasing passive income. He blogs about his journey to early retirement at Retire by 40.