Many people know they have a choice regarding how they take their Social Security benefits, but fewer know the basics of how to determine the best strategy for their personal situation. While Social Security rules seem endless and the benefit calculations complicated, there are a few factors that form the foundation of an informed decision.
First, you must start with an understanding of the basics of Social Security retirement benefits. You can log into your Social Security portal at any time, even long before you’re eligible for retirement benefits. If you haven’t started benefits and you’re not retired, the benefits page will show you an estimated benefit for your Full Retirement Age, or FRA (between 65 and 67, depending on when you were born). Taking benefits at your FRA is only one option. While anyone can start benefits at their FRA, if you have low or no earned income, you can begin taking benefits as early as age 62. Most people can defer taking benefits to as late as age 70.
But why would anyone in their right mind wait until 70 if it’s possible to get benefits earlier? Because benefits increase by 8% for every year you defer past your FRA. Likewise, for every year you take benefits before your FRA, they decrease by about 6.7%.
So now that we know what’s at stake, how do we decide when to take benefits? For most of us, there are three major factors that influence when we should take our Social Security: life expectancy, returns, and risk.
Deferring benefits makes sense if you expect to live past average life expectancy. The amount you forgo by deferring the start of benefits past FRA is offset by the higher amounts you receive in later years. For example, if you expect to live only to age 75, the larger payments from age 70 to 75 will not make up for the payments you’ve given up from FRA to age 70.
Returns can make money received earlier worth more, but since people earn different rates on their money, the extra value of receiving money early varies from person to person. Someone who deposits their Social Security benefits into a checking account and earns nothing on it will gain more by deferring benefits compared to someone who earns 6-7% in a balanced portfolio.
Consider the following example. If you take $1000 at age 62 and earn 7% for 8 years, it compounds into $1,718. If you put that same $1000 into a checking account, it would still be pretty close to $1000 after 8 years.
The 7% return your investment account gains comes with investment risks. There’s no absolute guarantee about what will happen with that money.
Social Security, on the other hand, is a promise from the U.S. Government, however much talking heads love to prognosticate on the future of the organization and its benefits. I’ll argue that the increase you gain from deferring your Social Security benefits is more certain than the 7% return you may gain from taking early or FRA benefits and investing them yourself.
Deferring your Social Security benefits also reduces your longevity risk—the risk that you will live longer than expected. This seems like a risk we’d all like to have, but from a financial perspective it increases the possibility that you may outlive your money. Deferring benefits mitigates this risk because every dollar increase to your Social Security is an additional dollar you’ll receive every month for the rest of your life. If your FRA benefit is $2,500 per month, then deferring from age 66 to 70 will increase your payments by $900 per month, or $108,000 over the course of a decade. That’s a meaningful number if you live ten years longer than you thought you might. Social Security benefits also increase with inflation each year, so larger benefits translate into greater inflation protection.
Life expectancy, returns, and risk are the building blocks of a solid Social Security strategy. This post used simplified examples to show how these factors can affect your decision, but real life is more complicated. Some of the other factors that can change the calculus behind a Social Security strategy include sources of alternative funds and spousal, disability, and survivor benefits. What’s more, you may develop a sound strategy, only to see your circumstances change. We’re proud to help our clients navigate all of these issues at Grubman Wealth Management.
In addition to knowing our clients’ finances, goals, risks, and habits, we use software designed specifically for optimizing their Social Security strategy. If you would like to know more, please contact us. You can also find us on Facebook, Twitter, or LinkedIn.