Be Careful When Using Your Social Security Statement for Planning

The Statement (Photo credit: Wikipedia)

Recently I received an interesting email from a reader (thanks, JRT!) that illustrates one of the problems with interpreting your statement from Social Security on a regular basis.  Part of the email follows:

I am just reaching 66 and have been self employed for many years.  I have worked continuously for 30+ years reaching $100,000 or so per year  but have been slipping into retirement and last years income dropped to $70000. SS has already reduced my monthly payment estimate.  It appears that if I postpone beginning taking my SS retirement I will lose in the long term because each year I have reduced income before retiring my SS distribution will be less. For instance if I defer to 70 and have 4 years with zero income won’t I be hurting myself???

In the situation described above, what the reader is describing is the amounts he is seeing on statements from Social Security.  When he was (for example) 64 years old, he saw a projected benefit at age 70 approaching the maximum benefit.  Then when he got his new projection a year later, after he had reduced his income for the most recently-reported year, the amount was less.  It appears that he’s losing benefits by delaying – right?

Not really.

The problem is with the way that the SS calculates your projected benefit.  They always assume two things that will tend to cause problems:

1. Your most recently-reported wages will continue at that same rate until you retire.
2. You will continue working until you file for SS benefits.

Jeff’s Statement at Age 64

So let’s work this out in an example.  FYI, I’ve done all of this work using the Social Security “Any PIA” online calculator.  The reader (let’s call him Jeff) was born in 1949, so in 2013 he is 64 years of age.  He has earned the Social Security maximum earnings from 1978 to the present.  When he receives his estimate for benefits at age 70, the projected amount of his benefit is $3,452.  (Note: When I plugged in the numbers for 2013 and 2014-beyond, I used the current max amount of earnings, $113,700, to reflect what SS does for the statement.)

If I go back and change the retirement age to 66, the benefit calculates to $2,579.  It’s safe to assume that if the situation was exactly as I described, Jeff would have received a statement showing him that information when he was 64 years of age.

Jeff’s Statement at Age 65

To estimate what would happen to Jeff’s estimated benefits the next year when he gets his statement, I changed his birthdate to 1948, and – since he indicated he is now earning less, I showed that instead of the maximum amount for 2012, 2013, and 2014-beyond, he actually projects to earn $70,000.  Now, his projected benefit at age 70 is $3,394 – since the future projected income is less than was projected a year earlier.  The projected age 66 benefit is now $2,571, also less than before, but by a smaller margin since fewer years are impacted.

Jeff hasn’t “lost” benefits – because the projected amount was only that, a projection.  Since the reality is that he received less in earnings than was originally projected, his accurately-projected benefit is now less.  In other words, the only way Jeff could have achieved the projected benefit is if he continued to work at the same income level ($113,700) as was projected for him.

Jeff’s Statement at Age 66

Taking Jeff’s last statement into account now – what happens if he stops working at age 66 and has four zero years?  To display this, I again dropped his birthdate back by a year, so that it indicates he is age 66 this year.  The past three years (including 2013) he has received earnings of $70,000 – but for future years, he will receive zero income.  Now the calculator shows a projected age 70 benefit of $3,306, which is likely to be very accurate – the only difference would be the annual COLAs that are applied (if any) between now and when Jeff reaches age 70.

Conclusion

So – as you can see, it can be dangerous to assume that the projected benefits on your Social Security statement are completely accurate for your situation, unless you actually will earn the same income between now and the date you begin receiving benefits.  In the case of Jeff, since his income is reducing and potentially going to zero for his last four years before age 70, the projected benefit from a couple of years prior was overstated.  The overstatement in this case was roughly $150 per month.