Don't Take Early Social Security Retirement If You Don't Have To

A few months ago I wrote The Best Age to Start Social Security. The bottom line of the piece was that the longer you wait to take Social Security benefits, the better off financially you'll be. Most people do the opposite and take early retirement through Social Security. Here's some information from Kiplinger's on why you shouldn't take early Social Security retirement if you don't need to:

Working longer may be the key to financial security for many future retirees who haven't saved enough during their working lives. Early retirees accept a permanent reduction in benefits of 20% or more for the rest of their lives.

Every year you work past age 62 boosts your financial well-being in retirement. Not only do you avoid a reduction in social security benefits and increase your annual income, but you also avoid having to touch your retirement accounts, so they can grow tax-deferred for another year. In addition, you shrink the period during which you have to draw down your savings, trimming the size of the nest egg you need in retirement.

As we've discussed before, you may not be able to work as long as you'd like to before retirement, but if you can, you certainly should. Here's the difference it can make for a person currently making $77,000 a year and needing 80% of that at retirement:

• Retire at 62: Potential Income Gap to Be Funded by Assets after Social Security -- $26,760
• Retire at 66: Potential Income Gap to Be Funded by Assets after Social Security -- $19,200
• Retire at 70: Potential Income Gap to Be Funded by Assets after Social Security -- $8,712

Wow! I never knew it made this much difference!

That said, I'm not planning on getting anything from Social Security. When I retire in 25 years, either it will be paying a minimum amount or nothing at all. I'm assuming the worst (also known as taking the conservative approach) and anything I get will simply be gravy.

Comments

[ChrisCPA]

Doing the math, if you are retiring at age 62 either way, it works out better to begin receiving SS...

[FMF]

Chris -- I'd be interested in your thoughts on this -- with details. YOu want to do the math for us?

[Lord]

Social Security is based on a 5% return. If you can do better, take it early, but no earlier than you stop working. That said, delaying retirement is giving up years of your life. If you like working then work, but if you don't and prefer not working (and many really don't have enough hobbies and interests to stop), then don't.

[ChrisCPA]

Maybe I should clarify that statement a little better...I meant to say that if you were forced to retire for some reason at age 62 (health, etc) and would no longer work, it makes more sense financially to begin taking SS distributions to fund retirement than to take funds from retirement accounts.

Say you will retire at 62 and you need to know how much money you have to have saved to break even at death. If you decide to begin taking the SS payouts at age 62 rather than 65, you would not be required to use as much personal savings to fund your retirement during the first three years. Those "saved" funds can be left in a retirement vehicle for longer to receive more return-say a modest 5% rate of return. The amount of extra Social Security (SS) benefits you would gain during retirement by deferring benefits until age 65 would not cover the extra funds you had to spend to fund the first three years of retirement.

In doing the math, I had to make some assumtions:

1)40 year old individual (unmarried)
2)Currently makes $50,000 per year
3)3% income growth rate
4)3% inflation rate
5)Retires at age 62
6)Starts collecting SS at 62 vs 65 vs 67
7)Lives in retirement for 30 years
8)www.ssa.gov SS benefit calculation is correct
9)Only $50,000 needed per year in retirement (future dollars-age 62)
10) SS benefits & retirement income needs increase each year to keep pace with inflation.

If you elect to receive SS benefits at 67, you would receive $32,349 per year.

According to the ssa.gov, your benefits decrease by 5/9 of 1% for every month you retire before age 67 up to 36 months & 5/12 of 1% for each additional month.

In our case it would be 59 months (you have to be 62 for one full month to begin benefits)at age 62 & 24 months at age 65.

(5/9*.01*36)+(5/12*.01*23)=29.6% reduction in benefits, or a monthly benefit of $22,779 at age 62

(5/9*.01*24)=12.3% reduction in benefits, or a monthly benefit of $28,036 at age 65.

In scenario 1, the individual would have to have $50,000 in year 1 of retirement & receives $22,779 in SS benefits-leaving $27,221 in retirement funds needed, this would come out of retirement accounts-leaving less to earn the 5% return. In the next year, the retirement income needed & SS benefits to be received would be increased by 3%-bringing them to $51,500 & $23,462-leaving a balance of $28,038 to come from retirement funds. The $28,038 is in future dollars & we would have to discount it back 1 year because, at retirement, we won't have to have that full $28,038 b/c our retirement accounts will (hopefully) earn 5% over the course of year 62. In year three, the same would happen only the retirement account funds needed would be discounted back two years. Repeating this for 30 years, our total PV of funds needed at retirement under scenario 1 would be $641,784.

Under scenarios 2 & 3, we have no SS benefits during the first 3 and 5 years, so we have to use more retirement account savings up front-thus lowering our invested earnings each year down the road compared to scenario 1. Using the same methodology the individual would need $649,452 when retiring at 62 & receiving benefits at 65 & $655,250 when retiring at 62 & receiving benefits at 67.

SS Age Funds Needed
62 $641,784
65 $649,452
67 $655,250

All three of these scenarios do not take into account fluctuations in return, risks, & tax consequences.

I used Excel to do this, hopefully my math worked out...

[FMF]

Wow, thanks. I'm going to digest it and likely use it for the basis of a future post.

[ChrisCPA]

Welcome.

I looked at the calculation & found that, in that situation, the break-even would be sometime in year 35 of retirement. Said another way, each plan would be basically the same (excluding all other factors) financially when that person reached age 97. So, a person would actually benefit more from choosing the other alternatives the longer they were retired...I don't think I'll be retired more than 35 years...