"When should I claim Social Security?"
History of Social Security
Social Security was signed into law in 1935 by President Roosevelt via the “Social Security Act.” The purpose then, and still is, to address the income gap in retirement by creating a contributory system where workers and employers contribute a percentage of their income to Social Security taxes. The tax is currently 6.2% per employee and 6.2% per employer for most individuals. Essentially, they believed the government would take care of these savings more prudently than the people.
Social Security comprises of roughly 40% of all income received by individuals 65 and older. As a financial planner specializing in retirement, you can see why this is an integral part of income planning for my clients. The decision when to file is irrevocable (at least after 12 months), so you can’t file and change your mind later. Therefore, it is important to consider both your retirement planning goals and estate planning goals when making this decision.
There are many complicated nuances involving widows, minor children, divorce, file and suspend, continuing to work while claiming social security etc. However, the primary question I receive from folks getting ready for retirement, is; “Do I take Social Security upon retiring or defer it?” In this article, I will provide questions to ask yourself and hypothetical scenarios to help get this conversation started and set a foundation for that important decision.
For retirement, you can claim Social Security anytime between ages 62-70. Depending on when you were born, your Full Retirement Age (FRA) is when you receive your standard benefit based on your wages throughout your career. You can log in or create an account on ssa.gov to view updates on your Social Security estimates. Here is a table below that illustrates what your FRA would be, based on your year of birth.
As you can see, FRA is anywhere between 65-67 years old depending on when you were born. Once you reach FRA, you can elect to delay Social Security until you turn 70. For most people, your monthly benefit would increase by 8%/year. Conversely, if you elect to take your benefit before FRA, your monthly benefit may go down by as much as 30%.
As we discussed earlier, this is an irrevocable decision, so prudent planning must take place. Because the highest monthly benefit is paid beginning at age 70, many people (financial professionals included), automatically recommend delaying until 70. I am here to agree for certain situations, but challenge that method of thinking for other situations!
If I delay to 70, what is the break-even?
There are many factors in play, but let’s use a simple example comparing an individual that begins Social Security at their Full Retirement Age of 66 vs. an individual that delays until 70. If we assume a reasonable rate of inflation, Social Security benefits would also increase over time. The Social Security Administration has averaged a 3.63% increase each year in Social Security payments since 1975. However, looking forward, our base assumption for inflation is currently 2.25%. Let’s call the client taking Social Security at 66, Karen, and the client taking Social Security at 70, Roxanne. Karen would be receiving four payments before Roxanne receives her first payment at 70. On the other hand, Roxanne has increased her monthly benefit by 8% each of those four years. Therefore, her monthly benefit is about 24% higher than Karen’s by the time they both turn 70 (Karen’s still increased with inflation). Let’s fast forward many years for both Karen and Roxanne collecting Social Security. The break-even point would be the year in which Roxanne has received a higher cumulative benefit than Karen. In this example, that age is 83.
If you could take out your crystal ball and see exactly how long you will live, making the claim vs delay decision could be very simple for you. The reality is, it’s more complicated. However, this is valuable information to know as a starting point and begin to ask the following questions:
- How healthy am I?
- Do I have longevity in my family?
- What is my portfolio withdrawal rate if I claim vs. delay?
- What are my legacy goals?
- Do I have long-term care insurance?
These are all relevant questions that will lead us to making the best decision for each client, so let’s address these next.
Health and Longevity
Built into our firm’s financial planning software, we have a very useful life expectancy calculator that serves as our best version of a crystal ball. However, there are many online tools you can use including John Hancock’s. If you have significant life expectancy in your family, you are in great health, a non smoker, than you have a reasonable argument to delay your Social Security to age 70. However, if you are not well, or don’t have longevity in your family, smoke, or simply think Social Security is going belly up, then you have an argument to take Social Security right away. I put a fair amount of time discussing the pros and cons and calculating my client’s break even point before them making the ultimate decision. Break-even on cumulative benefits, however, is not the only break-even point we use. Let’s take a look at the impact Social Security income has on portfolio withdrawals.
Social Security and the impact on portfolio withdrawals
For my clients, this is the heart of the Social Security decision. If I have a client who retires at 65 with a healthy military pension or significant fixed income from real estate, and they have no need for social security income to fill the income gap, then I would advocate delaying Social Security to 70. There is a scenario that argues against this, which I will address shortly. On the contrary, if that individual retires at 65, has no fixed income, and is relying solely on retirement and investment accounts, there could be an argument to taking Social Security at retirement rather than delaying until 70. Some may ask, “Why not rely solely on withdrawals from investments so I can let my Social Security grow by 8%/year for the next 5 years? There is no way to guarantee an 8% return in the market.” This is a valid question. However, the argument to taking Social Security at retirement, rather than delaying, is that you preserve your assets much longer simply by reducing your portfolio withdrawal rate!
I admit I am biased, but I am a bigger proponent for relying on assets on the balance sheet that are 100% liquid rather than relying on an income stream in the future from the government. Estimates currently say that between 2035-2040 Social Security is likely to run a deficit unless changes are made. The way to fix this is to raise taxes and/or change the way benefits are paid out.
Let’s compare the impact of the investment portfolio by taking Social Security at retirement (in this case 65) vs. delaying until 70. Let’s call the individual taking Social Security @ 65, Jarred, and the individual taking Social Security @ 70, Andrew. Let’s assume both Jarred and Andrew have military pensions that pay $30k/year, but they need an additional $131,000 in income from their investments and Social Security. Both of them retired with approximately $2,926,786 in their total investment portfolio. Given Jarred has Social Security income starting at 65, his withdrawal rate of the portfolio is 2.38% that first year. Conversely, Andrew has a withdrawal rate of 4.5% that first year given he is delaying his Social Security.
Let’s take a look at the withdrawal rate each of the first five years for both Jarred and Andrew:
As you can see, Andrew has a significantly higher withdrawal rate than Jarred for that first 5 years prior to taking Social Security. The impact this has on the portfolio is significant. After 5 years, you can see the total value is $3,278,999 for Jarred vs. $2,833,930 for Andrew. This is a difference of approximately $450k! If both of them unexpectedly passed away at 70, there is a substantial difference in financial legacy to their loved ones. Remember, Social Security is not an income stream you transfer to beneficiaries. Additionally, I always tell clients if they ran into an emergency situation where they needed capital, they can always use investments on their balance sheet. However, they cannot accelerate Social Security benefits.
If we use a simple average return and play this scenario out, we come up with a different break-even; I call it the break-even on the balance sheet. In this scenario, it is not until age 88 that Andrew’s investment portfolio finally catches up with Jarred’s. Therefore, factors like paying for unexpected expenses including long-term care, as well as leaving a financial legacy must be discussed in conjunction with longevity and health. Additionally, in this scenario both withdrawal rates are pretty acceptable. If, however, delaying Social Security results in an unacceptable withdrawal rate, anything north of 6%/year, there is a strong argument to begin Social Security upon retirement.
I am not going to go into too much detail about long-term care as I did write about it in a previous post Four Stress Tests For A Bulletproof Retirement Plan. However, I’ll just reemphasize the fact that assets on the balance sheet, or better yet, long-term care insurance, are a much more effective way to pay for custodial care later in life than a slightly higher monthly Social Security benefit. I always recommend stress testing a long-term care event, and seeing how it would impact your surviving spouse or other beneficiaries.
I don’t need Social Security, so take it and invest it!
I mentioned earlier there is a scenario where it could make sense to take Social Security right away, even if you don’t need it. If we think about someone who retires anytime before 70, and does not need Social Security income, the natural inclination would be to delay it to 70 in order to maximize the monthly benefit. I even stated this in one of the points above. However, if that client decides to take Social Security right away, they can turn around and invest that Social Security benefit in a well diversified portfolio. Naturally, that client is likely to do this anyways when they turn 70, given we already stated there is no need for Social Security. Therefore, the break-even analysis in this situation would compare taking Social Security early (let’s say FRA, or age 66) and investing that income vs. deferring Social Security until 70, and then starting the reinvestment process. If we run a simple projection (plug in any return you like), the break-even will happen somewhere around age 91 or 92. Therefore, this is certainly a compelling argument to consider taking Social Security right away in order to build up more liquid assets on your balance sheet.
Don’t let the pundits blindly tell you to delay. Incorporate all of the factors we talked about in this article to make the best decision for you and your family. Consider not just the break-even point on cumulative Social Security benefits, but the break-even point for your investment portfolio over time.
Prioritize your specific retirement goals and estate planning goals, and compare them to the income sources you have to pay for those goals.
All of the considerations above require planning and due diligence, including tax planning. Please consult with your advisors before making any decisions.
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Until next time, thank you for reading.