When to Commence Your Social Security Benefits

Many retirees have questions on when they should start their Social Security benefits. There are at least four things to consider. First, realize that your Social Security benefit is supposed to be one piece of your total retirement package (including pension plans, 401(k)/403(b) plans and personal savings). Thus, if you are contemplating retiring early and do not have much in regards to non-Social Security benefits, you may want to reconsider your retirement plans.

Second, realize that Social Security benefits are reduced by income from work ($1 for every $2 you earn above the earnings limit) if you start your benefits before your Social Security retirement age. Thus, if you retired early and are strongly considering going back to work, you may want to consider waiting until your Social Security retirement age to commence your benefits because you would not want to be in a situation where you lose benefits due to having too much income from work. Your Social Security retirement age is between 65 years old to 67 years old (65 if born on or before 1938, 67 if born on or after 1960, otherwise somewhere in between depending on year of birth).

Third, understand that Social Security benefits are reduced if you commence your benefit early (by 6-2/3% per year for up to 3 years early and 5% thereafter) and increased if you commence your benefit later than your Social Security retirement age (by 8% per year until age 70 for those who where born in 1943 or later, less if born earlier). Note, it usually does not make sense to delay commencing your benefits beyond age 70 (currently) because the benefits are not increased for delay retirement past this age.

Some people suggest taking your benefit early and save it. Their logic is that you can invest the money (to use later in retirement) because you can supposedly get a better return than the government can. Others suggest estimating how long you are going to live and if you are going to live a shorter than average life expectancy, then start your benefits earlier. If you are going to live a longer than average life expectancy, you should start your benefit later (up to age 70). There is a calculation (which I will show below) that has a breakeven life expectancy to be used to estimate when you should take your benefit. Yet, what most of the analysis focuses on the retiree’s life expectancy. However if the retiree’s spouse receives 50% of the retiree’s Social Security benefit, the age for this calculation is not really the retiree’s life expectancy, but the greater of the retiree’s life expectancy and his spouse’s life expectancy. This is because the benefit is paid out as long as one of them is alive (the spouse’s 50% benefit gets bumped to 100% of retiree’s benefit upon his death).

For example of the breakeven calculation, let’s assume the Social Security Retirement age is 66 with $1,000 a month Social Security benefit. Also, let’s assume that the retiree stopped working at age 62 and is considering when to commence his Social Security benefit (age 62, 66 or 70).

His Choices are:

Age    Benefit

62       $750 (25% decrease – 6-2/3% for first 3 years plus 5% for an additional year)

66     $1,000

70     $1,320 (32% increase – 8% increase for 4 years)

If the decision is to receive his Social Security benefit at 62 instead of 66, he will receive 48 months of additional payments by beginning the benefit at age 62. However, after 12 years (144 payments), it is better off (ignoring investment returns) to receive $1,000 beginning at age 66 than receiving a smaller benefit earlier. Thus, if he lives to 78 years old or older, it is better to start the benefit at age 66. Because the average life expectancy for a 62 year old is approximately 82 years old for male and 85 years old for female, it is usually better to wait, if the retiree can, to receive the benefit.

If the decision is to receive a benefit at 66 instead of 70, he will receive 48 months of additional payments by beginning at age 66. However, after 12½ years (150 payments), it is better off (ignoring investment returns) to receive $1,320 beginning at age 70 than receiving a smaller benefit earlier. Thus, if he lives to 82½ years old or older, it is better to start the benefit at age 70. Because the average life expectancy for a 66 year old is approximately 83 years old for male and 85 years old for female, it seems to be less of a compelling argument to wait. Yet, because the average life expectancy of a married couple (that at least one will be alive) is age 88, it is actually better off to again wait to age 70.

Note, the break-even calculation is an algebraic formula. Y is the number of months that it will take to live past the older age that makes receiving the larger benefit more beneficial than the smaller benefit that commences at an earlier age. For example,

(Y + number of months early) * Early Benefit=Y * Later Benefit

(Y + 48 months years) X 750= Y * 1,000

750Y + (750 * 48) = 1000Y

(750 * 48) = 250Y

Y = (750 * 48)/250

In other words,

Y = Early Benefit * (# of months early) / (Later Benefit – Early Benefit)

Y = 144 months (12 years)

Those who say to commence early and invest your Social Security benefit to make up for the lower benefit later in retirement point out that investment earnings will push this breakeven calculation out several years (instead of 144 months, or 12 years, it would be 14 years or more). This is true. Yet, if you are going to adjust for investment earnings, you should also adjust for inflation (because Social Security benefits increase by inflation). And, because of taxes and post-tax returns on conservative shorter-term retirement investments are probably similar, they offset each other in the calculation. In other words, if you can earn 5% on your short-term retirement investments and pay 1.5% of that on taxes (30% tax rate for federal and state taxes), it will be similar to 3.5% assumed inflation rate. Thus, the breakeven calculation for the example above is back to 144 months (12 years).

Yet, what many people do not talk about in their analysis of when to take your benefits is the longevity risk factor. One of the greatest fears in retirement is outliving your assets in particular due to outliving your life expectancy. The annuity benefit provided by Social Security is usually one of the larger offsets to this risk. Planning your retirement to live to your expected age (85) will cause a lot of stress later in life if you end up living to 95. By delaying your Social Security benefit (up to age 70), you will receive a larger benefit which will be useful if you live longer than expected. The risk with retirement is not dieing before you expected (and thus not getting your full share of Social Security benefits) but with living longer than expected and receiving a small Social Security benefit because you commence your benefit too early.

Forth item to consider is your individual circumstances and needs. There are many factors to consider including: life expectancy, investment and longevity risk, tax situation, your needs, etc. Thus, you should review your retirement plan with a financial planner before making a decision on when to start your benefits. Yet, do not forget about the risk of outliving your life expectancy where having a larger Social Security benefit would be useful.

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