Retirement at 65 can seem like a no-brainer to many Americans, as eligibility for Medicare, combined with a Social Security check, can feel like the payoff after decades of hard work.
But selecting a retirement age comes with a host of financial ramifications. For anyone born in 1960 or later, for example, Social Security’s full retirement age is 67. For these workers, filing for benefits at 65 is actually considered “claiming early,” resulting in lower monthly payments.
A retiree with a benefit of $2,800 per month at a full retirement age of 67 would receive about $373 less in monthly benefits by claiming at 65 instead. Over a year, that translates to about $4,480 in lost benefits.
Although future cost-of-living adjustments will apply, and the retiree would earn 24 additional checks over those two years, that lower starting benefit is locked in permanently. It would take roughly 13 years for the higher benefit from waiting to make up for the 24 checks received by claiming at 65, putting the break-even point around age 80.
Jay Pinkston, a certified financial planner and founder of Pinkston Wealth, said delaying retirement offers the double benefit of “two more years to save and two less years to take money out.”
Someone earning $80,000 annually, for example, would give up $160,000 in gross wages by retiring at 65 instead of 67. A worker who invested 10 percent of that money monthly over those two years could end up with an additional $32,000 in their nest egg, if they earned a theoretical 8 percent return and kept that money invested until age 75.
This same worker could earn additional employer matching contributions while enjoying two additional years of tax-deferred compounding in accounts like IRAs and 401(k)s.
Some workers may retire at 65, use savings for two years and wait until 67 to claim Social Security. Using more savings early means giving some of that money less time to grow. The trade-off is higher monthly Social Security payments for life. This strategy could also result in higher survivor benefits, if applicable.
This scenario can also open up a potential tax-planning opportunity. With little or no employment income, retirees may be in a low tax bracket, enabling them to convert traditional IRA savings to a Roth IRA at a relatively favorable tax rate.
This can be beneficial because traditional IRA withdrawals are generally taxable, while qualified Roth IRA withdrawals are tax-free. Converting during a lower-income year can therefore reduce the tax cost of the conversion.
“The years between retiring and claiming can be some of the lowest-tax years of your life, and they’re easy to waste,” Pinkston said. The conversion itself generally creates taxable income, however, and could also affect Medicare premiums, something to consider when making this type of tax-planning decision.
Medicare can play a big role in reducing health care costs for retirees, but for those with younger spouses not yet eligible for Medicare, it doesn’t solve the whole problem. A spouse who isn’t covered by an employer plan may require an expensive individual policy, in which case working a few additional years may be a consideration.
Even if waiting to retire makes more sense on paper, “it’s not just a financial decision,” said Robert Laura, co-founder and CEO of the Retirement Coaches Association.
Laura said that retiring earlier can offer plenty of additional lifestyle benefits, including reducing stress, improving well-being and offering more time to spend with loved ones. Travel also becomes more difficult as seniors get older. For many retirees, these choices can matter even more than earning additional paychecks.
There are many moving parts when it comes to choosing a retirement age, and the mathematics can vary considerably from household to household. Future retirees should consider everything from income, expenses and retirement-account balances to Social Security, health insurance and tax costs, at 65 and 67.
“There’s no perfect strategy,” Laura said. The goal is to understand what retiring earlier will cost and decide whether the trade-off is worth it.
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