If you understand the way the benefit is calculated, you can estimate the consequences of working an additional year.
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In general, you need 10 years of substantial earnings to qualify for a retirement benefit under social security. (You also have to be over 62 years of age and file an application.) Working additional years can qualify you for a higher benefit, even if you’re already receiving social security retirement benefits. The amount of added benefit can vary greatly, though, depending on your work history. Because of the way the social security benefit calculation works, you may get a big boost in your benefit, a small boost, or no boost at all. There are two main factors here:
- How do the earnings in the additional year compare with the lowest year that would otherwise count in your calculation?
- Are your average indexed monthly earnings above the second bend point?
Naturally, there are many other factors that may be equally important in determining whether you want to continue working (or return to work). We’re just looking at one issue: how it will affect your social security retirement benefit.
The discussion on this page will be easier to understand if you have read this page about how your retirement benefit is calculated.
No Reduction in Benefit
Having another year of earnings won’t reduce your retirement benefit. You don’t have to worry about dragging your average down, because your retirement benefit is always calculated on the basis of the 35 highest years, determined after applying inflation adjustments. Your additional year will go into the formula only if it would bring your average up, not if it would bring your average down.
Example 1: You’ve worked 33 years with earnings at a high level, and now you’re going to either work part time with a low level of earnings or stop working altogether. The calculation takes 35 years into account even though you worked fewer years. That means the formula includes two years with zero earnings. By working part time, you’ll replace a year of zero earnings with a year that has at least some earnings, and your social security retirement benefit will increase.
Example 2: You’ve worked 35 years with earnings at a high level, and now you’re going to either work part time with a low level of earnings or stop working altogether. If you work part time and have earnings lower than the lowest year in your prior history, the additional year will be ignored because it isn’t one of the 35 highest years. It won’t increase your benefit, but it won’t reduce your benefit, either.
If you have earnings during a year when you’re receiving early retirement benefits, the earnings test can cause a reduction in your social security benefits for that year. This will not affect your permanent benefit, however.
Replacing Years of Zero Earnings
As you can see from the examples above, you get an increase in your social security retirement benefit only if your additional year of earnings replaces a year when the earnings were smaller. You can be sure this is the case if your prior history includes fewer than 35 years of earnings, because that means your additional year of earnings will replace a year of zero earnings.
Example: Looking at the annual statement you receive from the Social Security Administration, you see that you have fewer than 35 years with earnings that count toward your retirement benefit. You are considering working an additional year when you expect to earn $42,000.
With fewer than 35 years of earnings, the benefit calculation will include some years of zero earnings. Working the additional year will increase your total by $42,000. Divide by 420 (the number of months in 35 years) to determine that your average indexed monthly earnings will increase by $100.
We still have to apply the benefit formula to see how this $100 increase in AIME will affect your benefit. We’ll get to that later.
Replacing Years of Low Earnings
If you have at least 35 years of earnings, it may be difficult to tell how much advantage you’ll get from working another year. We would need to apply an inflation adjustment to each of the earnings amounts to find out which are the 35 highest years. Then we would have to identify the lowest year out of the 35 highest, because that is the year that will be replaced if you have an additional year with higher earnings. It’s possible to work this out if you can locate the applicable inflation adjustments on Social Security Online, but it’s beyond the scope of this discussion to work through all the details. Here’s an example of how it might work out:
Example: You determine that your 35 highest years include 34 years with steady (and steadily increasing) earnings, plus one year you went back to school for additional training. You worked only a few months that year, earning $6,000. That was 25 years ago, and the relevant inflation adjustment indicates this is equivalent to $13,500 dollars today. If you work an additional year, earning $42,000, you’ll replace a year valued at $13,500 with a year valued at $42,000, for an increase of $28,500. Divide by 420 to get an increase of about $68 in your average indexed monthly earnings.
The preceding examples show that two different people with the same amount of earnings in an additional year of work can see a different impact on their benefit calculation. You get more bang for your buck when you’re replacing a year of zero earnings than when you’re replacing a year that had at least some earnings that count in the calculation.
The Benefit Formula
So far we’ve considered only the way your added earnings will affect average indexed monthly earnings (AIME). We have to apply the benefit formula to see how the increase in AIME will affect your benefit.
That formula provides benefits in three tiers. As a practical matter, anyone who is thinking about this issue of how an additional year of work will affect social security benefits is in either the second tier, where the 32% rate applies, or the third tier, where the 15% rate applies. People in the second tier get more than twice as much benefit from an increase in AIME as people in the third tier.
Example 1: Based on your earnings history, your retirement benefit is calculated at $1,000 per month. Working an additional year will add $42,000 to your earnings, increasing your AIME by $100. You are in the second tier, where the 32% rate applies, so the result will be a benefit of $1,032 per month.
Example 2: Based on your earnings history, your retirement benefit is calculated at $1,600 per month. working an additional year will add $42,000 to your earnings, increasing your AIME by $100. You are in the third tier, where the 15% rate applies, so the result will be a benefit of $1,615 per month.
The increase of $15 per month in example 2 may not seem like much, but you should bear in mind that it applies every month for the entire period you receive social security retirement benefits, and it will be adjusted for inflation over the years. It’s likely to provide you with many thousands of dollars in additional benefits. Yet the increase of $32 per year in example 1 is more than double that amount. In a borderline case, that would be a much stronger incentive to work an additional year.
Finding Your Tier
One way to find out which tier you’re in is to determine your AIME, and see if it’s above the second “bend point” in the benefit formula. (Bend points are explained in Step 5 on this page.) Unfortunately, it isn’t easy to determine your AIME, because the process involves inflation adjustments to numbers throughout your earnings history.
There’s an easier way, though. Based on the numbers in effect in 2005, you would have a benefit of about $1,570 at the top of the second tier. If your estimated benefit at full retirement age is at or above that number, you can expect additional earnings to fall into the third tier and produce the smaller 15% increment. Below that level your additional earnings will fall in the second tier and produce the larger 32% increment.
If you’re using the estimated benefit from the annual statement you receive from the Social Security Administration, make sure you’re looking at the benefit you would receive at full retirement age (even if you plan to retire early). Also, you have to take into account any additional earnings that are assumed in the statement. They assume you’ll continue earning at the same rate as in your most recent year. If their calculation already assumes you’ll make $42,000 next year, you won’t see an increase in the full retirement benefit when you actually earn that amount because it was already assumed in the estimate. In this situation, working the additional year will prevent a decrease in the benefit relative to the estimate.