The 1 Social Security Trap You Can’t Afford to Fall Into

Despite the fact that millions of seniors rely on Social Security heavily in retirement, there’s a lot of misinformation about the program. And sometimes, all it takes is a single misunderstanding to wind up with a lot less money in benefits than you may have anticipated. Such could be your reality if you wind up falling victim to this avoidable trap.

Claiming benefits early could backfire on you

Your monthly Social Security benefit is based on your wage history — specifically, the amount you earn during your 35 most profitable years in the labor force. You’re then entitled to that benefit in its entirety once you reach full retirement age, or FRA.

a man sitting at a table using a laptop: Older couple at laptop with serious expressions

FRA is not the same for everyone. It’s based on the year you were born, as follows:

Year of Birth	Full Retirement Age
1943-1954	66
1955	66 and 2 months
1956	66 and 4 months
1957	66 and 6 months
1958	66 and 8 months
1959	66 and 10 months
1960 or any time after	67

Data source: Social Security Administration.

Gallery: 15 Ways to Stay on Track for Your Dream Retirement (The Motley Fool)

What does the perfect retirement look like for you?

Some people dream of spending their retirement jet-setting across the globe, exploring new cultures and seeing famous sights. Others are content with a quieter retirement closer to home, surrounded by family and friends. Whatever your dream retirement looks like, it’ll probably cost a lot of money.

Saving for it can feel like a daunting task, but there are ways to make it easier to stay on track. Here are a few tips to get you started.

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1. Figure out how much you need to save

You won’t know whether you’re on track for the retirement you want unless you have an idea of how much it’s going to cost. If you haven’t already, try to estimate what your retirement expenses will be and how much you must save per month to reach that goal.

Use your current expenses and your retirement goals as a baseline, but remember that your spending will shift over time. You may spend less on child care, but you might spend more on travel. Take these shifts into account. Remember inflation, too. A good estimate for this is 3% per year.

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2. Have an emergency fund

Emergency funds help you cover unexpected costs, like a repair bill, medical expense, or job loss. If you don’t have an emergency fund, you may find yourself scrambling to come up with the money you need. That could force you to put off retirement savings, slowing your progress to your goal.

Keep at least three months of living expenses in a savings account. Six months might be better if you want to be extra safe or if you believe it would be difficult for you to find another job, should you lose yours. Always replenish your emergency fund after you use it so you’re ready for the next emergency.

3. Pay off high-interest debt as soon as possible

High-interest debt, like credit card debt and payday loans, can eat up a large chunk of your savings every month and make it difficult to save for retirement. If you carry that debt into retirement, you could drain your savings much faster than expected.

Consider a balance transfer card or a personal loan to help you get free of this debt. You may want to prioritize this before saving for retirement because the amount you’re paying in interest on your debt is likely higher than what you’d earn by investing your savings.

4. Trim the fat from your budget

Look over your current budget to see if there are any areas you can reduce your spending. This could involve canceling any subscriptions or memberships you aren’t using enough or cooking more rather than dining out. Simple actions like these can free up more money you can put toward your retirement savings.

Repeat this process at least once per year to see if you can identify any new savings opportunities.

ALSO READ: Retirement Plan Balances Grew in 2020. Did Yours?

5. Try to increase your retirement savings annually

If you’re not able to save as much as you’d like to for retirement right away, start by saving as much as you can. Then, try to increase your retirement contributions by 1% of your salary annually until you reach your savings target.

You should also increase your retirement contributions right away if you get a raise. Talk to your company’s HR department if you’re not sure how to update your retirement contributions.

6. Use the right retirement accounts

Each retirement account has its own set of rules that dictate how much you can contribute, when you owe taxes, what you can invest in, and when you can take your money out. Choosing the right account is crucial to helping your savings grow as quickly as possible.

Think about all the retirement accounts available to you — 401(k)s, IRAs, self-employed retirement accounts, etc. — and make note of their contribution limits, investment options, taxation, and withdrawal rules. Then, decide which one you’d like to put your money in first. Have a backup plan in case you max out your contributions to your first retirement account.

7. Get your 401(k) match

Some companies offer 401(k) matches to employees who contribute some of their personal savings to their retirement. This is a bonus you only get if you use your 401(k).

Talk to your company’s HR department if you’re unsure whether your company offers a match or how its matching structure works. Aim to contribute at least enough to your 401(k) each year to get the full match. Do this first before contributing to any other retirement account to ensure you get the extra cash.

ALSO READ: 3 401(k) Mistakes I Regret Making

8. Don’t forget about healthcare

Healthcare can easily cost retirees hundreds of thousands of dollars. If you fail to plan for this in your retirement budget, you run the risk of draining your savings prematurely. Medicare will cover some of your retirement medical expenses, but it doesn’t cover all of them. It also has costs of its own.

You can save for all your retirement healthcare expenses in a retirement account or a health savings account (HSA). These are special accounts available to those with high-deductible health insurance plans — ones with a deductible of $1,400 or more for an individual or $2,800 or more for a family in 2021. Money you contribute to these accounts reduces your taxable income for the year. If you use the money for medical expenses, you won’t pay any taxes on them at all.

9. Plan for taxes

Taxes are another frequently overlooked retirement expense. Unless you have all your money in Roth retirement accounts, you will owe the government something in retirement. You can use your estimates of your retirement spending and the current tax brackets to determine what you might owe.

Build these taxes into your retirement plan and think about how you can withdraw your savings to minimize taxes and help your money last as long as possible. One common strategy is to make proportional withdrawals. For example, if you have 75% of your savings in a 401(k) and 25% in a Roth IRA, 75% of your annual retirement withdrawals would come from the 401(k) and 25% from the Roth IRA.

10. Don’t pull your money out of stocks too quickly

You should gradually move your money from stocks to bonds as you age to help preserve the savings you have. But you don’t want to make this move too soon or too suddenly because you could miss out on the greater earning potential stocks offer. You’ll have to save even more on your own to reach your savings goal.

A good rule of thumb to follow is to keep 110 minus your age invested in stocks. So if you’re 40 years old, you should have 70% of your savings invested in stocks and 30% in bonds. Then, when you turn 41, you move 1% of your savings from stocks to bonds, leaving you with 69% in stocks and 31% in bonds.

11. Plan for Social Security

Social Security offers a consistent stream of income for retirees, though it isn’t enough to cover most retirees’ expenses on its own. Knowing how much you can expect from the program can help you determine how much you need to save on your own.

The easiest way to figure out how large your checks will be is to create a my Social Security account. This uses your actual income history and age to predict what your checks might be. There’s also a calculator you can use to see how different starting ages and annual incomes could affect your benefit.

ALSO READ: 3 Social Security Factors You May Be Forgetting

12. Avoid dipping into retirement savings early

You can withdraw money from your retirement accounts at any time, but you may pay a 10% early withdrawal penalty if you’re under 59 1/2. Some 401(k)s allow loans, which aren’t subject to this penalty as long as you pay the funds back within a certain time frame. But that doesn’t mean the loan doesn’t have an adverse effect on your retirement savings.

When you take money out of your retirement accounts, it’s not able to grow. That reduces your earnings and forces you to save more going forward in order to reach your retirement goal. Explore other loan options available to you before withdrawing money from your retirement account.

13. Use catch-up contributions if you’re 50 or older

Catch-up contributions are extra contributions adults 50 and older can make to their retirement accounts. While adults under 50 may only contribute up to $19,500 to a 401(k) and $6,000 to an IRA in 2021, adults 50 and older may contribute up to $26,000 and $7,000, respectively.

If you got a late start on retirement savings, catch-up contributions are one of the best ways to grow your nest egg quickly. These limits can change from year to year, so be sure to check them annually if you plan to contribute as much as you’re allowed to your retirement accounts every year.

14. Work longer, if necessary

Though not ideal, working longer can give you more time to save for retirement while shortening its length and cost. It also gives your existing savings more time to grow before you have to begin withdrawing them. If you’re not able to come up with the retirement savings you need any other way, this is one option to consider.

Working longer doesn’t have to mean sticking to your same nine-to-five. You could transition to part-time as you age if your company will allow it. Or you could switch careers and choose a job that’s more in line with your passions. Think about what makes the most sense for you.

ALSO READ: These IRA Mistakes Could Haunt You Throughout Retirement

15. Review your retirement plan annually

A lot can change in one year. You may not be able to save as much as you’d expected to if you lost your job or if your company took away your employer 401(k) match. Or you might save more than you anticipated if you got a raise.

These things can affect how much you need to save going forward in order to retire on the schedule you want. So it’s good practice to look over your retirement plan at least once per year to see if you need to make any changes. It’s easier to make small adjustments today than larger ones later in retirement, and reviewing your plan will give you confidence that you’re still on track.

Make your dream retirement a reality

If you follow the preceding tips, you should feel confident that you’re doing all you can to achieve your ideal retirement. It might take you a few decades to get there, but as long as you’re diligent about saving and you have a plan, you can get there eventually.

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17/17 SLIDES

However, you’re allowed to claim Social Security before or after FRA. If you delay your filing beyond FRA, your benefit will increase. But if you file ahead of FRA, that benefit will shrink.

Load Error

The earliest you’re allowed to sign up for Social Security is age 62. If you file at that age with an FRA of 67, your monthly benefit will be reduced by 30%.

But here’s one thing some seniors don’t realize until it’s too late — if you file for Social Security early, your full benefit won’t be restored once you reach FRA. Rather, you’ll be stuck with that lower benefit for life.

Say you’re entitled to a $1,500 benefit based on your earnings history at an FRA of 67. Filing at 62 will leave you with $1,050 a month instead. But unless you withdraw your benefit application within a year and repay the Social Security Administration all of the money it paid you, you’ll be stuck with that $1,050 for the rest of your retirement.

Now to be clear, when we talk about being stuck with the same benefit forever, that doesn’t account for the cost-of-living increases you may be entitled to through the years. Your $1,050 benefit may, for example, increase to $1,070 after one year and $1,090 after two years to account for the raises that seniors on Social Security are often entitled to. But your primary benefit — that $1,050 — won’t magically rise to $1,500 once you turn 67, and that’s something you’ll need to be prepared for.

Know the rules

A lot of people file for Social Security without even knowing their FRA in the first place. Others don’t realize it’s possible to get a do-over if you file too early. The best way to avoid making a decision you regret for years on end is to read up on how Social Security works. Understanding the program’s nuances will help you land on the best filing age based on your financial needs and life expectancy.

In fact, it’s a good idea to educate yourself on different filing strategies. In some cases, claiming benefits at the earliest age of 62 is a smart move. The key is to do your research and know the rules so you can feel confident moving forward with whatever decision you end up making.