Continued Work and Social Security Claiming Decisions

It is increasingly commonplace for people to work into their late 60s and even 70s. The percentage of people in these age groups who continue to view themselves as part of the work force has continued climbing for more than 20 years. The deep recession has been widely cited as forcing many older Americans to stay on the job and defer retirement, but the trend was well established before the downturn and is expected to continue even as the economy recovers.

This shift has been well documented and the details are nothing short of extraordinary. Here are the labor force participation rates for different groups of older Americans, as reported last month by the U.S. Bureau of Labor Statistics:

We are witnessing a statistically and socially significant shift toward continued work and extended careers for older Americans. For their part, employers are responding to graying work forces. Over time, and especially as the economy recovers, we can expect expanded employer accommodation efforts—more training, intergeneration communication and sensitization programs, and redesigned jobs reflecting age-appropriate roles for employees.

At the same time, however, employers should consider how continued employment in later age is altering retirement plans for millions of Americans. There is a solid opportunity and need here for human resource departments to better understand these issues and provide appropriate employee communications and training resources to older employees.

Work-based retirement programs such as 401(k) are an obvious focus for such efforts. The retirement assets of most people aged 55 and older fall far short of funding even modestly comfortable retirements. Encouraging and helping older employees to take full advantage of tax incentives and employer matches thus becomes a must.

As more 65-and-older employees stay on payrolls, Medicare options increasingly will enter the mix of health care considerations. There will be a growing appeal for hybrid solutions that permit employees, employers, insurers and Medicare officials to craft mutually helpful and innovative packages that represent better deals for all parties.

Less obvious, perhaps, is the changing role that Social Security can play in the retirement plans of older employees, and in the thinking of employers and human resource managers. For most Americans, the decisions about when and how to claim their Social Security benefits are far and away the most important retirement decisions of their lives and, in many cases, of the lives of their spouses and other family members.

Very few older Americans have even $100,000 set aside for their retirements. A typical Social Security benefit, by comparison, is akin to a guaranteed monthly annuity that would require a nest egg well in excess of $1 million to fund. That’s how important Social Security is to successful retirements, and it’s important even to people who earn a lot of money.

Every person participating in Social Security (some government employees and railroad workers have separate retirement programs) pays the same amount of taxes each year—in 2014, the rate is 6.2 percent of the first $117,000 in wage income. Employers also pay 6.2 percent and self-employed persons are on the hook for 12.4 percent of their earnings up to the $117,000 ceiling.

(There is a similar Medicare payroll tax—1.45 for employees and employers; 2.9 percent for self-employed persons—and this tax is applied to all wage earnings. Under Obamacare, there are additional Medicare taxes due from wealthier individuals.)

However, while contribution rates may be the same, the benefits available from Social Security are in no way the same for everyone. Social Security benefits have long been promoted as a common benefit—a “we’re all in this together” program. But its benefit provisions can vary greatly, and reflect complex choices that can make a huge difference to people. Social Security claiming decisions thus can play a major role in the retirement prospects of older employees and in the support and advice they need from employers.

People can begin claiming Social Security benefits as soon as their 62nd birthday. Or, they can defer their benefits and watch them increase in value each year by about 8 percent a year PLUS the rate of inflation. After the age of 70, benefits do not increase except for an annual cost of living adjustment (except they will increase for many people who keep working, and I’ll get to that shortly).

People are eligible for Medicare at the age of 65 and usually must sign up for the program unless they have private health insurance from an employer. But they do not have to sign up for Social Security at this time. And by waiting until they are 70, their monthly benefits—for the rest of their life—are 76 percent higher than if they began claiming at 62.

One of the additional core components of Social Security involves what happens to benefits when a person reaches what the Social Security Administration has called “full retirement age.” This is a confusing concept, made more so because the agency also calls it “normal retirement age.”

Now, because benefits can increase every year until age 70, you might think 70 is the full or normal retirement age. No, it isn’t.

Or, because Medicare benefits begin at age 65, you might think this is the full retirement age. No, again, although 65 used to be the program’s full retirement age before changes to the law raised this age. It is now 66 for people born between 1943 and 1954, and will rise by two months a year for those born between 1955 and 1960, reaching 67 for people born in 1960 and later years.

Reaching full retirement age has some enormous potential impacts on Social Security benefits. Prior to reaching full retirement age, anyone receiving basic Social Security retirement benefits can have those benefits temporarily reduced should their outside wage earnings exceed an annual minimum; in 2014, that minimum is $15,480. The ceiling on exempt outside earnings is higher for those reaching full retirement age in the current year; for anyone turning 66 in 2014, the exempt amount of outside earnings is $41,400.

For people receiving Social Security benefits who are aged 62 to 65 and earn more than $15,480, the agency will withhold $1 in benefits for every $2 of outside earnings; for those turning 66 who earn more than $41,400, $1 in benefits will be withheld for every $3 in outside earnings. This can make a big difference to older employees who have already started claiming Social Security (and while waiting until 70 can produce big monthly payment gains, nearly no one waits this long; 62 is the most popular claiming age).

Beyond withholding benefits, the way the agency does this can play havoc with an employee’s financial planning. If benefits are withheld, the withholding is not proportional or pro-rated during the year but happens all at once. A person receives $0 benefits every month until the amount of withheld benefits has been satisfied. Monthly benefits are then restored.

When a person reaches full retirement age, there is no penalty for outside earnings. In addition, the agency will restore any benefits that were withheld earlier because of outside earnings prior to reaching full retirement age. There are other significant implications of reaching full retirement age, particularly how it can affect decisions to take spousal, divorce and survivor benefits.

Lastly, older employees who continue working into their 60s and beyond can actually raise their Social Security benefits by continuing to work. A minimum of 40 quarters of work on which payroll taxes have been paid is needed to qualify to receive Social Security. But the agency bases an individual’s benefit entitlements on his or her 35 years of highest earnings.

An older employee who already has 35 years of covered earnings can boost his or her Social Security benefit if the amount earned in 2014 is large enough to become one of the top 35 earning years. The agency will automatically recalculate a higher lifetime benefit. Even people already claiming Social Security will see their benefit increase, and it will increase again for each and every year their future wage income is large enough to be one of their 35 top earnings years.

The agency adjusts annual wage earnings each year to reflect the impact of inflation. So, a year of wages earned in 1990 might be worth more than you’d think when compared to earnings in a more recent year. But when a person reaches the age of 60, the agency’s rules say that their wage earnings are no longer adjusted for inflation. So it’s very likely these later-year earnings by older employees will be included in their top 35 earnings years, and thus boost their Social Security benefits.

Few employees know about or understand these Social Security provisions. The same probably can be said about human resource managers. Yet the retirement prospects of older employees can be greatly affected—for better or worse—by their Social Security claiming decisions. As more and more retirement-age employees remain on the job, these decisions will grow in importance for employers as well.

Research Fellow and journalist Philip Moeller is the co-author of “How to Live to 100” and is now working on a book about Social Security, to be published by Simon & Schuster.