Updated from original publication in The News Tribune February 2014.
By Gary Brooks, CFP®
For many, claiming Social Security at age 62 (a common practice) could reduce long-term financial security, rather than enhance it.
The great majority of people claim Social Security benefits before their full retirement age as defined by the Social Security Administration. In 2015, 69% of men and 74% of women claimed Social Security at age 62 and, thus, received permanently reduced benefits. (Source: Social Security Administration Annual Statistical Supplement, 2016.)
Those who claim at age 62 receive 25% less than if they waited to full retirement age and 75% less than if they claimed at age 70. Of course, many people claiming early do not have financial options to do otherwise.
Among those who have saved a retirement nest egg and chosen to retire, some pair early Social Security with the assumption that they should postpone use of employer retirement plans or IRAs for as long as possible to extend the benefit of investing with pre-tax dollars. However, for some people, the opposite course – using IRA/401k withdrawals as a source of income while postponing the start of Social Security – can actually improve the longevity of the investment account and its tax efficiency while paving a path for substantially more guaranteed Social Security income.
For each year that you postpone the start of Social Security income after initial eligibility at age 62, you receive an 8% increase in your payment. In investment markets, there is certainly no guaranteed way to increase income or returns by 8%, especially for a conservative investor.
The decision isn’t quite so simple, however. There are many factors that influence the most optimal choice. Life expectancy, the size of your Social Security benefit in relation to your expected expenses, your spouse’s Social Security income, age and health, your expected investment return, how much of your nest egg is in after-tax Roth accounts vs. pre-tax accounts, and more personally specific issues.
Maximize Retirement Income
If you are retired at 62 but wait four years to 66 to claim Social Security, you may have to live on a bit less for the four-year period, but this action can buy a higher standard of living through the longer remainder of retirement.
Using invested assets to methodically fill the income gap will likely cause the balance of savings to decline more sharply than you envisioned in the first handful of years while you postpone Social Security. But, once the larger Social Security payments kick in, IRA/401k withdrawals can theoretically level off or end until age 70 ½. In many scenarios, the longevity of the investment portfolio can be improved vs. starting smaller Social Security payments earlier and supplementing them with larger pre-tax investment withdrawals throughout retirement.
Which path is right for you should be determined through purposeful planning. How do you know which route is better for your personal situation without modeling the “what if?” choices to see how different decisions impact the probability of funding your goals?
For some people, optimizing income solely for their own lifespan is the goal. For others with bequest motives – or a younger spouse – the claiming strategy might be different.
By evaluating different scenarios that are based on your situation, you can make more informed decisions and plan accordingly.
Fear of Waiting
Some people claim Social Security early, because they need the income on which to live. Others, however, do so out of fear that if they die early, they will not receive back what they paid via decades of payroll taxes. This is another example of the instant gratification society we live in that generally disregards long-term thinking.
Waiting for larger payments later in life means you have to live to a certain point to exceed what you could have received in smaller payments over a longer period of time. Generally, this breakeven age is around age 81. If you live beyond 81, then deferring Social Security was a better financial choice.
Actuarially, if you live to the average life expectancy (ages 84 for men and 87 for women), starting smaller payments early should be close to neutral to larger payments later (with breakeven being age 81). Those in poor health may lean towards the former, while those in good health may have a significant chance of living past the breakeven period. So, delaying Social Security may be a better choice.
Along with potentially dying early, many people are concerned about the future of Social Security. While Social Security income could be challenged by an aging population, it is not an all-or-nothing scenario. Even without any adjustments to the way Social Security is funded, there will be enough workers to provide recipients with about 77% of current benefit estimates. Likely, there will be future adjustments which would maintain expected Social Security payments, especially for those who most need it.
Determining when it is best to claim Social Security should be a part of your retirement strategy. It’s important for you to understand the pros and cons of various options. Defaulting to claim benefits at age 62 could result in financial consequences that may grow more burdensome as you age.
Subscribe to our monthly newsletter for insights on money, markets, and personal finance.