Consider Delaying Social Security Benefits

Here's a piece courtesy of Marotta Asset Management that recommends delaying the receipt of Social Security benefits:

Over seven out of every ten Americans opt to receive their Social Security checks as soon as possible. This is usually a mistake. By delaying when you start receiving your benefits, you may receive more money and ensure you have a better retirement in the long run.

Part of the confusion about timing Social Security benefits stems from the fact that full retirement age isn't the same for everyone. For Americans born between 1943 and 1954 full retirement age is 66. For everyone born before or after those dates, the full retirement age is set on a sliding scale between age 65 and 67.

You can wait until your full retirement age to begin benefits, or you can opt to receive benefits as early as age 62 or as late as age 70. Most people decide to take the cash early and run. By taking Social Security at age 62, your monthly benefit is locked in at a much lower payout rate, forever.

However, if you wait until age 70, you will receive your full monthly benefit plus additional money for being patient. After age 70, there's no additional benefit increase, so there's no point in delaying benefits any further. The bottom line: the longer you wait, up to age 70, the higher your monthly benefit.

According to the Social Security Administration, it doesn't matter which option you choose. But, the numbers tell a different story.

When it comes to timing your Social Security benefits, delayed gratification does pay off. For retirees born in 1943 or later, benefits increase by 8% for each year you delay receiving your benefit. In addition to the 8% increase in benefits, your actual payment will also be indexed for inflation! In other words, if inflation is running at 3%, your actual benefit amount will increase by an impressive 11% for each year you delay taking the benefit!

This still doesn't answer the big question: Is it better to get a smaller payout for a longer period of time or a bigger payout for a shorter amount of time? As a rule of thumb, the longer you expect to live, the more likely the later payout will pay off.

Let's consider an example. Triplets Peter, Paul, and Mary, born in 1941, are presented with identical benefit options. Each can opt for a monthly benefit of $758 at 62. They can wait until full retirement age of 65 years and 8 months for a benefit of $1,000. Or, they can delay benefits until age 70 and receive $1,312 per month.

Peter couldn't pass up the opportunity to take the earliest possible payout. He locked in his payout at $758 beginning at age 62. Paul decided to wait until his full retirement age (65 and 8 months) to receive his $1,000 monthly check. Mary decided to wait until age 70 to get a monthly benefit of $1,312.

And although Peter was the first to begin collecting his money, he didn't end up with the biggest total payout. By the triplets' 78th birthday, Paul's benefits had surpassed the total payout Peter had received. And although Mary didn't begin receiving her checks until age 70, soon after the triplets' 83rd birthday, the total value of Mary's benefits had outstripped both of her brothers'.

Upon the triplets' death at age 90, Peter had received $254,688 in total benefits. Paul had received $291,000, and Mary had received $316,192.

In other words, the longer you expect to live, the better off you'll be opting for the age 70 payout. But, does that mean you should spend down your savings, waiting for the bigger benefit?

The best plan is to keep working until age 70. That way, you can both delay taking benefits and avoid tapping into your savings. If you are unable to keep working, choosing between early benefits or draining your savings while you wait for the higher payout requires some very careful thought.

In general, the lower the returns on your portfolio, the better off you'll be spending down your savings while you wait for benefits to kick in at age 70. If your savings are just keeping pace with inflation, you'll be better off waiting for the age 70 payout, if you live past the age of 83.4 years. If your portfolio is earning a real return of 2.5% annually, your "breakeven" age is 87.25 years. In other words, you will be better off with the age 70 benefit if you live longer than 87 years and 3 months --assuming an average bond yield on your nest egg.

If you think living into your 80s or 90s in improbable, you may want to think again. Americans are living longer. The American Society of Actuaries reports that a 65 year-old male has a 50% chance of surviving until age 85. Women fair even better. At age 65, the average woman has a 50% chance of surviving until age 88. Taken as a couple, there is a 50% chance that one spouse will survive to age 92. With the improvements in medical technology, these numbers are likely to climb even higher.

Waiting for the higher payout is like buying longevity insurance. By delaying benefits until age 70, you can better protect yourself from outliving your money. And remember, for each year you delay taking the benefit, your 'insurance policy' will give you an 8% benefit increase plus cost of living adjustment. Even an aggressive stock portfolio would struggle to match those returns!

One further reason to wait for the higher payout is to protect your surviving spouse from running out of money. Social Security pays spouses a survivor's benefit ranging from 75% to 100% of the original benefit amount. By taking the later payout at a higher rate, you will ensure a higher survivor's benefit for your spouse and any dependents after your death.

The best way to stay both physically and financially healthy is to keep working at least part time until age 70. By working, you stand to make a paycheck and to grow your social network. Plus, you won't need to dip into your investment portfolio. In the mean time, the interest you earn on your investments between the ages of 65 and 70 will do more to boost your bottom line, more than any Social Security payout strategy ever could.

There are other reasons to be wary of the early payout. Retirees who both work and receive benefits before they reach full retirement age may see their benefits dramatically reduced. Until you reach full retirement age, your benefits will be docked $1 for every $2 you earn above an annual limit. In 2007, the limit is $12,960. But, once you reach full retirement age, you will no longer be penalized for working.

Furthermore, don't be tempted by the myth that you can beat the system by taking the early benefit and investing it. To break even with this strategy, you will need to earn an 8% real return above inflation. If inflation is running at 4%, you will need to earn a 12% annual return just to keep up. Trying to earn a 12% return year after year in your own portfolio is a very risky proposition. Chasing after double-digit returns when you could simply delay your guaranteed benefit and watch your future pay increase by 8% over inflation is a fool's bet.

There is one main exception to this rule. For some, poor health leaves them with little option but to begin receiving the benefit as early as possible. Seniors struggling with poor health may be wiser to take the earlier benefit, assuming they may not live long enough to make the higher payout worth the wait.

Likewise, if you are much younger than your spouse and your spouse's income was larger than yours, you may want to start taking Social Security early. If they predecease you, your benefit will be increased. For everyone else, the early payout may just be a bad choice.

You should consider carefully when you take Social Security benefits and seek professional advice for your specific retirement path.

Comments

[broknowrchlatr]

I went through this calculation and determined that for me, it is best to take the money earlier. Even at a low return on the money, the additional income earned by waiting never overcomes the power of compounding.

The same is true with my pension.

If I take the money at age 55, I get about 24% of the money I get if I take it at age 70. If I get a modest 8% return on the money, the break-even point is age 85. At 9%, it is age 91. And, at 10%, there is no break-even point.

[Brad]

BNRL:

But if you're already in retirement, will you be putting the money in higher-risk investments that can earn 8-10%? Perhaps some will be in stocks, but you'll probably be keeping the principal safe to a certain degree as well. So you may want to see what it looks like at lower levels- say 5 or 6%, which is what half bonds/cash and half stocks may give you.

Still, this is one of those fun situations where you are betting on your own death. Personally it seems better to assume you'll live a long time. If you're wrong, then you won't be around to see what you missed out on anyway. :-)

[broknowrchlatr]

Using the 11% rule, for every $100 taken at age 62, you could have a more impressive $230.45. Then the break even points are age 82.5 for 8%, 85.5 for 9% and 91 for 10%. You could argue that these are low enough to justify taking the money early or that insuring against inflation is a good idea. I'd rather take the money and invest it. After all, I plan on this being supplemental income.

I suppose delaying payment is better if you plan on this beign your only income.... or if you expect to live till 100.

[Dave]

Dear FMF,
Great job doing the math and getting comments about this often misunderstood topic!

[Dan]

I would take the money as soon as possible, they can always reduce your value through political means but money you have already taken would be hard for them to come after. I don't even expect it to be there so when I turn the right age, I am going to snap it up.

[Lord]

The flaws in this article are so severe it needs a big caution around it, reading it may be hazardous to your financial health.

First, the 8% 'rule' applies only if you continue to work and contribute to SS. What you are actually doing is shortening your retirement life. If you are are not working, the actual discount rates are 4% real for early retirement and 2% real for late retirement. If you can't beat those you have worse problems than you imagine. If you anticipate a long life expectancy, much longer than 85, then delaying it may make sense, but how many 85+ people do you know traveling the world? Having more to spend on healthcare seems like a twisted set of values to me.

[David]

Here's a question on when to begin taking social security benefits. Let's say I'm 61 years old and my wife is 58 years old (three years younger). Let's also say that I have worked for more than 30 years and will be entitied to a relatively high amount of social security benefits, while my wife has worked for about 15 years, at a lower salary and will be entitled to a relatively small amount of social security benefits.

Could I decide to delay the receipt of my social security benefits until my full retirement age or until age 70 but have my wife begin collecting her small benefits when she turns 62? If we choose to do this, would she still be entitied to 50 percent of my benefit when I begin collecting social security at my full retirement age or at age 70?

Is this a strategy we could use? If so, as a couple we would receive a small payment from the time my wife turns 62 until the time I reach my full retirement age or age 70. We would also, as a couple, receive a relatively high payment when I begin collecting my benefits.

[Livingalmostlarge]

Personally I'll delay to 70, but longevity runs in the family. My Great-Grandma is 99 and still kicking, grandma is 79 and dad is 78. My other grandma live to 95. I think I have a good shot of living a long time.

But to other people? Maybe they should take it earlier. They don't have longevity on their side.

[Dave]

As I slept on this overnight, I wondered -- my normal retirement age is 2032 -- will their even be SS by then?

[slipshade]

Even with a modest return on investment (say 5%), there is never a break even point for delaying your earnings. That is to say, you can never earn as much if you delay. The author's number are just way off. But I am assuming of course that you have the discipline to not spend any of your earnings until the equivalent of when you would have delayed until. To make this perfectly clear: YOU CAN MAKE THE MOST BY TAKING IT EARLY. (caveat: every situation is different, just don't let these guys bully you into retiring late)

Here is an example. Fact: for every $1,000 you would earn at age 67, you earn $715 at age 60. That's based off the SSA reduced retirement rate. Then assuming you will earn $1,000 at 67 (the numbers scale, so if you would have earned $1,100 or whatever the basic results are the same) it follows that: Net Worth at 61 (NW61) = $715 * 12 = $8580. Using simple annual compounded interest at 5%, NW62 = NW61 * 1.05 + ($715 * 12) = $8580 * 1.05 + $8580 = $17,589. Using the same formula, NW63 = $17,589 * 1.05 + $8580 = $27,048. NW64 = NW63 * 1.05 + $8580 = $36,980. NW65 = $36,980 * 1.05 + $8580 = $47,409. NW66 = 47,409 * 1.05 + $8580 = $58,360. NW67 = $58,360 * 1.05 + $8580 = $69,858.

It was painful to write that, but hopefully I've spelled it out so that everyone can follow that the person who takes the money at age 60 basically has $70,000 in the bank at age 67. Now with $70,000 in the bank that person makes ($70,000 * 0.05) / 12 = $291 per month in interest. Add that to the $715 the person is getting from SS and by my calculations that is more than the $1,000 you would get for waiting until age 67. That is to say, living off interest and reduced SS, you will make more that you would by waiting. NOT TO MENTION THE $70,000 IN THE BANK.

Oh alright. I didn't account for inflation. (I'm still not entirely sure that the $715 to $1,000 comparison at the SSA site doesn't take inflation into account, but I'm no expert). But with 3% inflation over 7 years this only amounts to 23% total inflation (1.03^7). So at most that would give the guy who held out until age 67 a ($1,000 * 1.23) - ($715 + $291) = $224 monthly advantage or $2688 yearly advantage. In this case, the break even point would be defined as 67 (his current age) plus [$70,000 (all the money the other guy has in the bank) divided by $2688 (the yearly advantage)] = 67 + ($70,000 / $2688) = age 93.

Now not everyone is going to save all the money, and of course if you work an extra 7 years you are going to make 7 more years of money. But point is, it is not such a nice cut and dry equation as some of these pundits would have you believe. Don't feel bad about taking the money early, and don't feel superior because you can hold out. Fact of the matter is the equation is different for every story. In my case, I'll be saving most of it due to other pensions, and I doubt I'll live to see 93. But even if I see a hundred, I'll only be down less than $20,000 from having waited it out. And according to current mortality rates odds are I won't even see 80.

Just food for thought