[dropcap]L[/dropcap]ike most things the government is involved in, Social Security is entirely more complicated than it should be. One of the more confusing aspects is when to start collecting. At its core, the decision is the same as buying an annuity. By giving up money now, you get a larger income stream for life. Like annuities sold by insurance companies, the key variable is how long you live.
If you live longer than most, it is usually better to delay. If you die sooner than most, it is better to start taking the money sooner.
Unlike annuities from insurance companies, the immediate “price” paid to delay social security payments is often a good bet. The soonest you can start receiving payments is 62 and the latest is 70.
If you were born between 1943 and 1954 (and you probably were if this article is of interest to you), your “normal retirement age” is 66. By starting at 62, you would receive only 75% of your full payment per year. By delaying to 70, you could add 8% per year, or 32%, to the annual total.
All else equal, this means if you expect to live well into your 80s or beyond, you should delay taking payments, and if you expect to die before your mid-seventies you should start taking them as soon as possible. I assume you have other assets or income to help you live now. If you need to start taking social security early for basic living expenses, then your decision is made by necessity. Even in this case, it is often best to wait until at least your normal retirement age if possible. But there are other important variables to be considered.
If you are single, it is a pretty straight forward decision. Simply guess if you will outlive the “breakeven point” after accounting for some reinvestment rate. There are a bunch of calculators online that can help with that, some better than others. The basic breakeven points for a single person are something like this:
Live less than 78 years: Take early payments at 62
Live 78-82 years: Take full retirement payments at 66
Live more than 82 years: Delay payments until 70
These assume you are not reinvesting the payments. If you assume some type of historically normal investment return, and you should, add another 3 years or so on to each of these cut-off points.
If you are married, things naturally get more complicated. Each spouse has the option of taking their own benefits, or half of what their spouse is entitled to. However, if one dies, the other is entitled to the full amount the other was getting if it is more.
This means the decision to delay benefits for the person with the higher benefits should be based on the life expectancy of both members. Especially if the lower earning spouse is younger and female (women live longer). All of this usually argues in favor of the higher earner waiting until at least the full retirement age and probably all the way until 70. On the other hand, the lower earning spouse becomes encouraged to start taking payments sooner.
A spouse can begin taking benefits early based on the other person’s earnings even if the other person chooses to delay beyond “normal retirement.”
Here’s an example where the husband is older and made more money. The wife will be receiving benefits based on the husband’s amount.
Husband Age: 61
Wife Age: 57
Husbands “Normal Retirement” Benefit: $1,000
Husband’s Benefit if he starts at 62: $750
Husband’s Benefit if he waits until 70: $1,320
Spouse Benefit if she starts at 62: $325
Spouse Benefit if she waits until 66: $500
There are only four possible scenarios:
Scenario One: Both die relatively soon and neither lives into their 80’s. In this case, both should start taking income as soon as possible.
Scenario Two: The wife dies relatively young and the husband lives relatively long. Here, the wife should start as soon as possible. The husband is probably better off delaying, but maybe not.
Scenario Three: The wife lives a long time and the husband dies relatively early. Here, the wife should still start as soon as possible, because her benefit will revert to what her husband was getting at death. If she lives a long time, it is better for the husband to delay even though he dies early, because she will get the increased benefit for a long time.
Scenario Four: Both live a long time. In this case, both should delay.
Obviously, there is a lot of grey area between these examples. However, a good strategy in this scenario is often for the wife to start taking income at 62 while the husband should delay until 70. For most couples where the wife is the same age or younger than the husband, I believe this is the best strategy.
This approach becomes increasingly less effective if the wife was the same age or older than the husband or is not basing her payments on her husband’s benefits.
If you are still working, it is usually best to delay starting payments until at least your Normal Retirement Age, unless you really believe you will die relatively early. If you make any kind of reasonable salary and take early benefits, the government will start to reduce your social security payments substantially. They do credit them back to you in a way that does fairly compensate you later, but it still largely defeats the purpose of taking the income early. Also, if you are working, you may not need the social security now and can probably afford the risk of delaying.
Pay it Back
This discussion would not be complete if I did not mention the option to start taking benefits early and then change your mind. The government lets you pay them back and then start over as if you delayed. This creates all sorts of headaches and most people ignore this option. Still, it is something to think about because you may have a better sense of your longevity after a few years. You should discuss this with a financial planner if it is of interest.
There is no right answer about when to start taking social security. Especially if you are single, the expected values tend to come out about the same unless you have a good idea about your longevity. If you are married, the higher earning partner, (especially if it is the man who tends to have shorter life expectancy) should usually wait until at least full retirement age and usually even delay the maximum amount.
Most financial advisors suggest taking the money as soon as possible. There is some logic to this, but many people can do better.
My philosophy is to try and play for the best expected return if you can afford to do so. Further, when in doubt, I suggest a preference to delay (especially for the higher earning spouse). The reason I feel this way is because the main reason delaying can be a mistake is if you die early. However, if you die early it is usually not as much of a financial problem as living longer than expected can be. In other words, the extra social security money earned by starting early is unlikely to mean as much in a short time horizon as the extra money earned by delaying will in a long time horizon.
Craig Birk, CFP®
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