Early retirement has tremendous lifestyle benefits, but sadly, some drawbacks too. To rise above the rest, you need to enter the world of early retirement with your eyes wide open because here, ignorance is not bliss; it’s catastrophic.

Social Security is a lifeline for most retirees, and early retirement is no exception. If you pay into the program, you deserve your benefits — they can be the difference between comfort and struggle.

Make sure you understand the rules, the pitfalls, and the loopholes. When you reach age 62, you have important decisions to make, and by then, it’s too late to start figuring it out.

Here are some critical Social Security facts that you need to know.

The early-retirement effect:

Social Security is structured to replace about 40% of an average worker’s income when they have a career spanning 35 years or more. It’s a progressive program, meaning that lower earners have a greater percentage of their income replaced.

If you only work for twenty or thirty years, you’ll escape the clutches of traditional employment, sure, but some of the Social Security Administration (SSA) rules will work against you.

Social Security calculates benefits based on your top 35 years of income. Retire early and some of your years will be $0.

If you work in a conventional job, paying into the system for less than 35 years, the SSA fills those empty years with $0 when calculating your average income. With a lower average income, you simply get less.

But you will get some benefits, and those will be a higher percentage of your overall average earnings. How much will you get? It’s tricky, but I’ll show you an easy way in a minute.

First, you should know some key facts about the program and how it will affect you.

• You can start taking benefits at any time on or after your 62nd birthday.
• To get any benefits at all, you need to hold a job that pays into the system for at least 40 quarters (10 years), earning more than about $1,500 a quarter. They don’t have to be consecutive quarters of earnings. You just need a total of 40 quarters or more in your career.
• When calculating benefits, the SSA looks at your top 35 years of earnings and ignores the rest.
• If you retire early with fewer than 35 years of earnings, they’ll generously put $0 in the years that didn’t qualify, which drags down your average.
• When calculating your benefits, the SSA will adjust your prior years of income to match today’s dollars. For example, if you made $20,000 twenty years ago, the SSA would consider it to be somewhere close to $35,000 today when calculating benefits.
• There is no minimum benefit, but there is a maximum. In 2021 the highest earners would receive $3,148 if they retired at full retirement age (FRA).

For more on FRA and other SSA facts, check out this article: Everything You Need to Know About Social Security

The retirement algorithm

The SSA uses a multi-step equation to calculate your future retirement benefits. It is tied to the year you reach age 62, the earliest you can elect to receive benefits. You can always choose to take benefits later, of course — between age 62 and age 70 — these calculations just serve to establish a baseline.

Step One: They take your top 35 years of earnings and adjust them into today’s dollars. Any missing years get zeros.

Step Two: They add them up and divide by 420 (there are 420 months in 35 years) to get your “adjusted monthly earnings.”

Step Three: They multiply your “adjusted monthly earnings” by the following factors:

a) Multiply the first $926 by 90%

b) Multiply the amount between $926 and $4657 by 32%

c) Multiply the amount over $4657 by 15%

The result: The sum is the amount you would receive each month in today’s dollars. If you aren’t turning 62 today, you can approximate your future benefits by adding about 2% per year until you retire. That covers the anticipated cost of living increases.

Now, the easy way

It’s not hard to make some general assumptions and end up with an approximation of what you’ll receive in Social Security benefits if you retire early.

Using the grid below:

1. From the bottom, estimate the number of years you plan to work in a job that pays into the SSA system.

2. On the left, estimate your average income during those years. I’ve already added zeros in your non-work years.

3. The intersection is your benefit amount when you turn 62 (in today’s dollars).

An example:

Suppose you plan to work a 20-year career as a carpenter while you save and invest heavily for your early retirement at age 45. Let’s say right now; you’re making about $60,000 a year with overtime. The grid shows you’ll receive $1,061 a month if you elect to receive benefits at age 62.

Further, (not shown in the chart) if you decide to start receiving your benefits later than age 62, you’ll get a nice surprise. The SSA increases your benefits by about 8% per year from 62 to 70. That means if you wait until you’re 70, your $1,061 increases dramatically — to over $1,800.

Remember, these are in today’s dollars, so you can understand how they fit into your cost of living right now. If you want to convert them into future dollars, add about 2% a year for inflation.

Congratulations! This isn’t chump change. When you’re planning an early retirement, and you have a guaranteed safety net later in life, you’ll have greater confidence and reliability in your financial security. That goes a long way toward your retirement freedom.

Charting your course to retirement

Now is a good time to revisit a few principles of successful retirement planning. Early, on-time, or delayed retirement — these principles apply to everyone:

• Know what you need to live on when you retire. That requires planning, which you’re doing right now. So… congratulations!
• Save a significant portion of your income — 20% for average people — more if you’re older or retiring earlier. Learn to live on less and buy only what you need.
• Invest in a diversified portfolio that includes income-generating assets. Those can be dividends, real estate, or even a side business. Talk to an expert. In fact, talk to several.
• Plan for contingencies. If you need $4,000 a month, add a 10–20% buffer.
• Don’t over-plan for something ridiculous, like a 50% buffer. If you do, you’ll be working for much longer than you need to.
• You don’t get extra points for dying with the most money, so cut the cord when you know the time is right, enjoy your life, and adjust as you go.

Remember…

Retirement is complicated, unpredictable, and frightening, so it’s easy to keep putting it off until it’s too late.

Most people spend more time planning a vacation than their retirement.

Don’t be like them — you could end up facing the very real prospect of financial and emotional difficulties. Planning is essential in early retirement or any retirement.

Here are some thoughts to keep in mind as you polish up your plans to make your retirement the best it can be.

• No matter what you do, you can never remove all the risk. You’ll be successful when you manage the factors that are within your control and worry less about everything else.
• Expect to make course corrections as you age. Try to minimize your long-term fixed expenses (mortgages, loans, subscriptions), so you can adjust your variable expenses (food, entertainment, travel) up and down as needed.
• Don’t try to cheat the system. I have a friend who hid all his income offshore, and when he recognized his retirement would be completely without Social Security or Medicare, he fessed up, paid a ton of penalties and premiums, and straightened it all out. He’s getting less than he would have if he’d been completely honest up front.
• Any amount of income is better than the zero you get from the SSA if you have fewer than 35 years of income. Work an extra year, take a part-time job, declare your rental income, and ensure they’re aware of every dollar you’ve paid into the system.
• Even when you’ve worked for 35 years, if the 36th is higher than any of your other years, it will increase your benefits by raising your average income.
• Your best strategy to maximize your Social Security benefits is to live a long and happy life. Stop smoking, exercise, eat well and reduce your stress (which for many, is to retire early)
• Talk to people: retirees, pre-retirees, financial planners, lifestyles planners, retirement coaches, friends, and family. Tell them your plans and ask for their feedback.

Talk to me too. Let me know what you think, and good luck in your retirement planning. Trust yourself and enjoy yourself. I’ll see you on the other side!