Social Security Retirees Face Unexpected Downside of Early Retirement

Key Points

• Retiring early can result in a reduced Social Security claim.

• Most people know that early filing penalties reduce the amount they receive.

• Your Social Security benefits could also be smaller for another unexpected reason if you claim benefits early.

• The $23,760 Social Security bonus most retirees completely overlook ›

Retiring early is a dream for many, but there are some definite financial consequences. Not only do you need to start relying on your savings sooner and have fewer years to save, but you could also reduce your Social Security checks.

Of course, one way an early claim could shrink your checks is if you claim benefits before age 70. Doing so reduces your monthly Social Security income, either because you get hit with early filing penalties or because you miss out on delayed retirement credits available until 70.

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However, there's also another unexpected way you could reduce the money you receive from Social Security -- and you need to take this into account when you decide if early retirement makes sense for you.

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Could this move shrink your Social Security benefits?

Retiring at a young age can actually have a bigger impact on your Social Security benefits than you'd think, and that's because of the way that the benefit formula works.

Your standard Social Security benefit that you receive at Full Retirement Age is calculated based on a percentage of your average wages over your 35 highest earning years (after adjusting wages to account for inflation).

If you work less than 35 years, which is entirely possible, then you shrink your check as a result of the inclusion of $0 wage years in your average benefit. If you work exactly 35 years, then you don't have those years of $0 wages included -- but you may have some years that are factored into your average when you earned very little if you were unemployed for part of the year or just starting out in your career.

For many people, income increases as you age. If you are earning more, and especially a lot more, than you did early on in your life, retiring early when you are making so much money could mean you lose the chance to replace some lower-earning years with years at your new, higher salary.

This drags down that average wage, leaving you with a smaller Social Security check for the rest of your life.

Should you try to work for at least 35 years?

Since working for 35 years (or longer) can increase your benefit, it may make sense to do that if you can. Of course, this won't make sense, or be possible for everyone, and it isn't useful if you took a lot of time off work (say, to care for kids) and you can claim your benefits based on your spouse's work record instead of your own.

It also may not be necessary to give up years of time in retirement by staying in the workforce longer just to increase your monthly Social Security benefit -- especially if you have a lot of money in your retirement plans, and you aren't going to rely on Social Security as a major income source.

Still, as part of your retirement planning process, it's worth thinking about this potential impact on your benefits when you are deciding if early retirement makes sense.

If you are worried your 401(k) isn't quite big enough, or aren't confident you'll have enough money to last you for the rest of your life, then staying those few extra years on the job to boost your Social Security benefit could give you a lot of peace of mind -- as well as more time to save.

A higher lifetime benefit is inevitably going to beat out a lower one in terms of providing financial security, so while you may decide the trade-off of working longer isn't worth it, it's at least worth considering the impact of early retirement on your benefit checks before you give notice.

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