The time is right to revisit Social Security’s claiming formula

The early retirement penalty is too severe, but the delayed credits are about right - in most cases

The current Social Security claiming formula hasn’t changed much since the early 1980s, and its roots trace back to the 1950s. I was asked during a recent webinar presentation if I thought the system needs adjustment - and it’s a great question. So, I went back to do some research on this topic, which resulted in my latest Morningstar column.

The amount of monthly benefit you receive from Social Security revolves around the Full Retirement Age (or FRA)--the age when you can receive 100% of your earned benefit, or Primary Insurance Amount (PIA). Currently, the FRA is 66 plus a few months, depending on your year of birth; it is headed to 67 for workers born in 1960 or later under reforms enacted in 1983. The early claiming formula reduces benefits by 6.7% for every 12 months before your FRA and increases payments by about 8% after age 66 for every 12 months up until age 70 (when further credits no longer are available).

The delayed credits and early claiming penalties were designed to be fair from an actuarial standpoint - you should get the same total benefit over the course of your lifetime no matter when you file, assuming average longevity.

But researchers at the Center for Retirement Research at Boston College examined the formula in light of changes in longevity over the years. They conclude that the delayed credit is still about right, with the exception of the highest earners, who tend to outlive actuarial averages and reap the highest extra benefit. Conversely, the group hurt the most are low-income filers, who tend to claim earlier and effectively are overcharged for doing so.

Moreover, the increase in FRA from 65 to 67, enacted in the reforms of 1983, effectively increased the penalty for earlier filers. Claimers with an FRA of 67 will receive five years of early filing reductions rather than three.

I’m not suggesting that the delayed credits should be changed - the political friction that would generate is not worth the effort, especially since the formula is inaccurate for a very small percent of Social Security claimers - those in the highest income bands. As I noted earlier this month, the percent of workers who delay their claim to their late 60s or age 70 is very small.

But reducing the penalties for early claiming would be very helpful, especially for people who find themselves forced into retirement by the pandemic. It makes sense to make these changes as part of any future Social Security reform legislation.

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