more_or_less said:
If I "early-retire" now -- at age 57 -- and I don't work at another job until a I start taking Social Security when I am 67, will I be penalized for not working from the time I'm 57 to 67?
The short answer is no. You will not be penalized for not working during the next 10 years. What this means is that the value of your previous Social Security contributions will not be directly impacted by what you do in the next 10 years. In your case, your benefit likely will be slightly higher if you do work but the difference will be small (and probably not worth 10 years of work).
Social Security benefits are calculate as follows (
http://www.ssa.gov/pubs/10070.pdf).
Multiple the salary for each year of employment by the Index Factor (wage adjustment) for that year. Only use the salary up to the SS maximum. For example, if a person made $39,600 in 1985 (the SS maximum for that year), multiple this by the 2007 Index Factor for 1985, which is 2.20 ($39,600x2.20 = $87,120). This is the adjusted salary for 1985. Choose and sum the 35 years with the highest adjusted salaries. Divide by 420 (number of months in 35 years). This is the average adjusted monthly earnings in current 2007 dollars (the average over the 35 highest income years).
For example, if a person made the SS maximum for the last 35 years, the adjusted monthly salary would be $6841. Multiple the first $680 of the adjusted salary by 90%. Multiple the amount over $680 but less than or equal to $4100 by 32%. Multiple the amount over $4100 by 15%. The sum of these three values is the monthly SS income for a person retiring today at their full retirement age. In this case, it is $2117. For an individual who has worked 30 years, the monthly SS income would be only $100 less, or about $2017. However, since previous wages are indexed upward each year, these will correspond to the approximate monthly salary in today's dollars for a person who is 57 years old today, stops working, and starts to collect SS at their full retirement age in 10 years.
Should the 57 year old with 35 years of wages continue to work another 10 years? If they do, their average adjusted monthly salary (in today's dollars) 10 years from now will be greater because the SS maximum is higher today than it was 35 years ago. That is, the next 10 years will have more SS value than the first 10 years of their working career and will therefore replace the first 10 years when the highest 35 years are considered. But the amount isn't large. Making assumptions about the next 10 years, a person's average adjusted monthly salary in today's dollars might be $7470. Using the formula's above, their monthly SS income would be about $2212, or $95 higher than if they do not work the next 10 years.
In summary, for a person as described above who is 57 today and starts collecting SS at full retirement age (approximately, in today's dollars) ...
35 years: $2117 monthly income vs $2212 monthly income for 10 additional years of work
30 years: $2017 monthly income vs $2212 monthly income for 10 additional years of work
Not much difference.
The reason additional work is not very valuable in terms of SS monthly income is because: 1) the Index Factor for previous years is adjusted upward every year, meaning that your past wages maintain their relative value; and 2) for higher income individuals (those with 20 or so years at the SS maximum), the multiplicative value for each additional dollar contributed to SS is only 0.15 (as opposed to 0.90 or 0.32 for individuals with more modest incomes). It doesn't pay to work.