April is National Social Security Month. For many Americans, social security is the primary or maybe even the only source of income they receive in retirement. As we work with our clients to plan for retirement an important part of the discussion centers around social security and more specifically, WHEN to begin drawing the benefit.
So, when should you turn on your social security? If you are not yet at the age and/ or are not familiar I'll start by listing your options.
1. Early Social Security – 62 years old is the earliest that the average person can turn on social security. This is considered early social security. If you choose this option you are limited in the amount of EARNED income that you can have in a given year. If you go over the threshold you will be subject to a fairly stiff penalty. The important thing to remember is that this is EARNED income (think W2).
2. Full Retirement Age – this is generally considered to be 66 ½ years old but it depends on your age. If you were born in 1960 or later full retirement age is 67. In my opinion, this moving target will continue to go up as life expectancy continues to increase. I would imagine that the full retirement age will be closer to 70 in 20 years. Your income will be higher than early retirement and you have no income limitations. You can continue to work and earn income without penalty.
3. Delayed Benefits – if you wait until age 70, your benefit amount will increase during the time you delay. No income limitations just like full retirement age.
***There are no specific dates you have to use when applying for the benefit. Any time after 62, you are free to turn on your benefit. The amount will increase every month you delay until 70.
The earlier you take your benefit the less the payment. Taking the benefit at 62 will reduce the amount you take compared to the full retirement age anywhere from 25% - 30% depending on your date of birth. Anyone born after 1960 should assume a 30% reduction in their payout if they take it at 62 (ssa.gov)
By that simple logic, it would only make sense to wait as long as possible to take your benefits, right? Historically that had been the most popular opinion from many “experts” on the subject. The idea is that if you live a long life this will yield a far greater sum of money in total. For example, the average monthly social security benefit in the United States is $1,693 or $20,316 per year. Taking the benefit early would reduce the benefit by 30% or $1,185/month.
By waiting until full retirement age you will receive $6,094 per year. That’s a significant monthly increase for the average American. Also keep in mind that the amount theoretically doubles for a married couple and could be higher depending on your earnings (this was simply the US Average from SSA.GOV).
Okay, so it seems like the answer should always be to wait to take your social security so that you benefit from a higher income for the rest of your retirement life, right? Not so fast. There are many factors to consider when thinking about when to take social security. Below are what I consider to be the top three factors when making a decision.
Factor #1 – Life Expectancy
Most of the opinions surrounding the “wait to take” theory of social security center around protecting longevity. The longer you live, the more the dollars stack up. A person who turns on social security at 67 and lives 25 more years will draw an additional $152,350 over that 25-year time frame. Someone who lives only 5 years gets significantly less benefit and actually earns less money than the same person taking the benefit at 62. If we knew the age we would die, this calculation is very easy. Unfortunately (or fortunately if you ask me), we don’t know and so this discussion shifts from being a science to being more of an educated guess.
Factor #2 – Break Even Analysis
The higher benefit of waiting sure sounds nice but before we make the decision we need to know our breakeven. Remember, the person who turns on benefits at 62 has a 5-year head start on the person who waits until 67. Let’s use the example above and pretend we have two identical twins, John and Bob.
John decides to take his social security at 62 and Bob decides to wait until 67.
John begins drawing $14,221.20/annually at 62 and receives that benefit for 5 years (Bob has delayed his social security until 67 and makes nothing during this time). On their 67th birthday, John has received $71,106 in total benefits and Bob has received $0. Bob now begins receiving his benefit of $20,316/year which is $6,094.80 higher than John’s benefit. How long does it take for Bob to break even on his decision to wait (classic word problem from grade school).
That means Bob does not benefit from the decision to wait until he is almost 79 years old. He spends almost 12 years simply catching up to his brother John. He is now nearing 80 when he begins to financially benefit from the decision to wait.
Factor #3 – Retirement Spending Behavior
I have been a financial advisor since 2008. During my tenure, I have observed many retirees and their spending behavior. Based on this observation I have come to the following conclusion. Retirees spending behavior tends to follow a pattern. While this is not inclusive of everyone, I do find it to be the common form of spending. The pattern is broken into three distinct stages.
Early Retirement
This is the beginning stage of retirement. People tend to be excited and begin checking off their bucket list items. Major purchases such as homes, cars, RVs, and big vacations tend to take a sizeable portion of their budget. Medical care tends to be preventative in nature. Discretionary spending is at an all-time high.
The Satisfaction Phase
This is the phase of retirement where major purchases and travel begins to decline. Individuals tend to spend more time at home and seem very satisfied with the people they know and the possessions they have acquired. Their desire to travel has diminished. While the specific age varies depending on the individual, the theory is what I’d refer to as the “satisfaction phase” of retirement. Your discretionary spending declines to a more modest level and the cost for healthcare is still reasonable. This time is often spent in an income surplus. The need for money has declined because many of the purchases are in the rearview mirror. This is a time in life when debt is at an all-time low, assets are often at an all-time high. An individual's need for cashflow has reached its all-time low.
The Long-Term Care Phase
This is the time in life when many people are no longer able to live independently. This may mean in-home care, a Long-Term Care Facility, or a nursing home. Discretionary spending is now extremely low but healthcare/long-term care costs are extremely high. Spending is now at a level that is unsustainable for their portfolio. For most people, this phase is very short (1-3 years) and so the cost is normally not a concern as longevity is not the issue. If long-term care insurance has been purchased and can be accessed it will help to offset the cost of care.
Final Thoughts
In summary, if we don’t know how long we will live and can assume that our discretionary spending will be higher from 62-75 then it makes sense to at least consider taking social security early if you retire before full retirement age. Doing so will allow you to live a more comfortable retirement and take less from your portfolio than you would if you had delayed the start of benefits to full retirement or beyond. It also ensures you will maximize the number of years you draw the benefit. While this is not a blanket recommendation for everyone it’s a philosophy that we use when helping clients determine their start date.
If you have questions or would like to discuss your situation further, please contact our team.
