By Craig Erwin, Ph.D. 12-8-20
It is best if you have few or no gaps in your employment history. It also helps if you had high paying jobs, because, the higher your pay, the more was deducted from your paycheck for Social Security. If you have only held part-time jobs, you can expect to receive very modest Social Security checks. If, however, you have worked full-time at jobs with high compensation, you can expect much higher Social Security checks.
Employment gaps can do substantial damage to retirement savings when they come early in a career. Even though you are unlikely to be able to contribute nearly as much per paycheck early as you can late in your career, the early money is more important because it has decades to grow through compounding. Thanks to compounding (earning interest on the interest you’ve earned), a few dollars can turn into a substantial sum over decades. In contrast, the money you contribute just before you retire has little time to grow, so what you contribute as you near retirement is not likely to grow much before you need to start using it.
Social Security is different. It doesn’t matter whether your earnings are taxed early or late in your career. The only thing that matters is the total amount that was deducted from your paycheck during your working years. If you didn’t contribute to the pot by working and having money deducted from your paychecks, you won’t receive payments after you retire (unless you were married long enough to collect based on your spouse’s (or ex-spouse’s) contributions or unless you have a disability or are blind. Employment gaps clearly matter.
In my teens I worked part-time in a supermarket for several years. Since I worked part-time and was paid minimum wage, even though I contributed to Social Security steadily, the total amount I contributed was not great. But, it was far better than nothing, which is what some of my friends contributed (the ones without jobs).
After I quit working at the supermarket, I worked sporadically until I finished college. But, every penny contributed to Social Security helps. Once I finished my Bachelor’s degree, I began earning much more than I did working part-time and I paid much more into Social Security. Over time my salary kept increasing, which resulted in greater Social Security deductions from my paychecks.
I had a few gaps in employment between the time I received my Bachelor’s degree and the time I finished my Ph.D. I backpacked through Europe for 6.5 months, which left quite a gap. Fortunately, when I was working, I often contributed to retirement savings plans aggressively.
Would I advise my sons (or other young adults) to travel abroad even though it would likely mean less money saved for retirement? Absolutely! But, I would tell them to go in with their eyes open; to acknowledge that there is an opportunity cost to travelling.
Some things are priceless; traveling is one of them. A comfortable retirement is another. The next time you are faced with an employment gap, consider the likely consequences. It can make a big difference!