Why taking Social Security early costs too much

Starting Social Security early typically means getting a smaller benefit for the rest of your life. The penalty is steep: Someone who applies this year at age 62 would see their monthly benefit check reduced by nearly 30%.

Many Americans have little choice but to accept the lower payments. Even before the pandemic, about half of retirees quit working earlier than they had planned, often due to job loss or health issues. Some have enough savings to delay claiming Social Security, but many don't.

But the penalty for early filing, and the bonus for delaying your application, are based on old formulas that don't reflect gains in life expectancy, said economist Alicia Munnell, director of the Center for Retirement Research at Boston College. The result is a system that unfairly penalizes early filers, unjustly benefits late filers — and hurts lower-income people the most.

"Low-income people disproportionately collect benefits at 62 and their benefits are cut too much, and high-income people disproportionately delay claiming till 70 and their benefits are increased too much," Munnell said.

Originally, Social Security had one retirement age: 65. In 1956, Congress passed a reduced benefit for women, to allow them to retire at the same time as their typically older husbands. Men received the reduced benefit option in 1961.

The amount of the reduction was meant to be "actuarially neutral," so that the cost to Social Security would be the same whether those with average life expectancies claimed the smaller check earlier or the larger check later.

As life expectancies rose, though, early filers endured the penalty for longer. In 1956, a 65-year-old woman had an average life expectancy of 16.9 years. Today, it's 21.6 years, Munnell said.

Let's say your full retirement age is 67 and your benefit, if started then, would be $1,000 a month. Starting at 62 would shrink the benefit to $700, while waiting until 70 to begin would boost the amount to $1,240.

The longer you live, the more you can benefit from a delayed filing. Between 2001 and 2014, for example, life expectancy rose by more than two years for men and nearly three years for women with incomes in the top 5%, according to a study for the Social Security Administration. During the same period, life expectancies for those in the bottom 5% of incomes rose a little less than four months for men and about two weeks for women.

To restore actuarial fairness, the penalty for early filing should be lower, Munnell said. Someone who retires at 62 instead of 67 should get 22.5% less, rather than 30% less. Similarly, the bonus for waiting should be reduced to just below 7% per year.

Obviously, Social Security has bigger problems. Once its trust fund is depleted, as projected in 15 years or so, the system will be able to pay only 79% of promised benefits in 2035.

Congress should consider making the payouts more fair, Munnell said. "I think there'll be some grand bargain on Social Security at some point because I don't think anybody's really going to allow benefits to be cut 25 percent," Munnell said.