Retired early ... and getting scared

Walter Updegrave is a senior editor with Money Magazine and is the author of "How to Retire Rich in a Totally Changed World: Why You're Not in Kansas Anymore" (Three Rivers Press 2005)

Ultimate Guide to Retirement

• Getting started
• 401(k)s & company plans
• Investing
• Annuities
• IRAs
• Self-employment plans
• Pensions and benefit plans
• Social Security
• Insurance
• Estate planning
• Living in retirement
• Getting help

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NEW YORK (Money) -- Question: I had the good fortune to be able to retire early at age 52, but last year's market meltdown has made me rethink the decision. I may still be okay, but I don't have the same level of certainty I once had. My question is this: How will Social Security be calculated for me and how does the fact that I haven't worked the last few years fit into the calculation? --Jack Ford, West Newbury, Mass.

Answer: Before I answer your question about how your Social Security benefits are calculated, I want to address the uncertainty you're feeling about whether you can afford to stay retired.

You're not alone. Given the beating retirement savings accounts have taken over the past year, many retirees are wondering whether they will need to "unretire" to one degree or another to avoid having to ratchet back their lifestyle or run through their assets too soon. A recent study by Charles Schwab & Co. estimates that as many as 9.5 million retired Americans are considering at least a partial return to the workforce.

And going back to work -- full- or part-time -- can make a lot of sense. The extra income allows to pull less money from an already battered nest egg, giving your savings a chance to recuperate from last year's hammering. Depending on the size of the paycheck, you may even be able to throw some new money into savings.

The rub, of course, is that now isn't exactly a great time to be looking for a job. The latest reading on unemployment continues to show a rising trend with the September rate creeping up to 9.8%. And older job seekers, especially ones who have been out of the workforce in recent years, will generally find it harder to find a job than their younger counterparts.

That said, I still think it makes sense for you as well as any other retiree who's concerned about his financial security to consider finding work. You may not land your dream job or pull down as big a salary as you would like. But if you go about the search in the disciplined and systematic manner described in "The Right Way To Unretire," you'll boost your chances of getting a job.

Now, back to your question about how your Social Security benefits are calculated.

First, to be eligible for Social Security benefits based on your own work record, you must earn a minimum number of "credits." Generally, that translates to at least 10 years of work, but you can get the particulars on the Social Security Administration Web site.

Assuming you clear that hurdle, the question becomes how large a check are you entitled to? That depends on two things: your lifetime earnings and the age at which you start collecting.

Let's start with earnings. Basically, the Social Security Administration looks at how much you earned each year you worked and adjusts each year's figure to reflect increases in wage levels over time. So if you had a job that paid, say, $5,000 in 1967, that amount would be adjusted to just under $39,000 today to reflect the rise in salaries over the past 32 years. This process assures that you don't get short shrift for years early in your career when wages were generally smaller in nominal terms than today.

The Social Security Administration then calculates your average monthly earnings based on the 35 years in which you earned the most money. If you worked fewer than 35 years, it calculates the average based on the number of years you did work, although a shorter working history translates to a lower average and smaller payment. Social Security then applies a formula to this monthly average -- essentially, a weighting system that stunts the increase in the size of your benefit as your earnings rise -- to arrive at what is known as your Primary Insurance Amount, or PIA. (For the sake of brevity -- and sanity -- I've left out a lot of details in this explanation.)

This is where the age at which you begin collecting comes in. Your PIA, or primary insurance amount, is the Social Security benefit you're eligible for if you retire at your full retirement age. Depending on when you were born, your full retirement age varies between 65 and 67. For people born between 1943 and 1954, for example, the full retirement age is 66.

You can begin collecting Social Security (barring disability and other special situations) at 62. You should know, however, that you can increase the size of your Social Security check pretty dramatically by waiting until your full retirement age or later to collect.

Let's say, for example, your full retirement age is 66 and that, based on your current work record, you would be eligible to receive $1,000 a month. If you decided to collect at 62, that amount would be cut to $750 a month. Conversely, if you wait until age 70 to collect, you would receive $1,320 a month. Whatever amount you receive will be adjusted annually for inflation (although given that consumer prices are projected to stay flat or fall in the near term, the Congressional Budget Office estimates that Social Security recipients may not receive a cost-of-living increase for the next few years.)

The fact that you haven't worked the last few years won't affect the size of the Social Security check you're already entitled to based on your work history. You'll get credit for the years you worked and your wages for those years will be adjusted to reflect rising wage levels as I described earlier. The benefit formula doesn't penalize you for not having worked in recent years.

That said, it's possible that you might have qualified for a higher amount had you stayed on the job, either by adding more years to your work record if you're short of the maximum of 35 or, even if you're not, by replacing an earlier low-earnings year.

Which is another reason, aside from the job income, that you as well as other retirees might consider going back to work. The Social Security Administration takes earnings from all work years into account when calculating benefits and reviews Social Security payroll records regularly. If working later in life, even after you've begun collecting payments, boosts your average lifetime earnings, the Social Security Administration will automatically increase the size of your check.

There are other issues you need to consider, including the fact that working while collecting Social Security could temporarily reduce your benefit and possibly subject it to income tax. But going back to work and delaying collecting Social Security to give yourself a bigger check for the rest of your life are two strategies certainly worth thinking about if you're looking to enhance your retirement security for the long term.