Social Security is one of the most important sources of income for many retirees. What is the best way to maximize your lifetime benefit? Should you take it early and invest it? Delay your benefits to let them grow? The answer depends on several factors, such as your life expectancy, your expected rate of return, and your legacy goals. In this blog post, we’ll analyze the value of delaying your social security benefits in the context of your life expectancy and investment returns.
When you take social security before your full retirement age, your benefits go down by 6.67% for the first 3 years before full retirement age and then go down by 5% each additional year until age 62. If you delay your benefits you can gain an additional benefit of 8% per year until age 70. Full retirement age is based on the year you were born:
Breakeven Age For Delaying Social Security
One of the simplest ways to analyze social security is to consider the breakeven age of delaying your benefit. The breakeven age is the age you need to live to where your total payouts will be equal whether you take social security early or delay. If you live past your breakeven age, then your total benefit will be higher if you delay.
The following table illustrates the breakeven age based on taking social security earlier (left column) versus delaying your benefit (top row). For instance, if you look at age 62 on the left and compare it to age 63 on top, it tells you that you’d need to live to age 77 to be better off taking the benefit at age 63 as opposed to age 62. If you look at age 62 on the left and age 70 on top, it tells you that you’d need to live to 80 to breakeven on delaying social security to 70 rather than taking it early at 62.
Here’s a table showing actuarial life expectancies with data from the Social Security Administration:
Comparing the breakeven ages in the previous table to actuarial life expectancies, you can see that on average a Social Security retirement benefit would be maximized if it was delayed and allowed to grow. However, this calculation does not take into account the opportunity cost of waiting.
Social Security Strategies With Investment:
Many who delay their Social Security benefits end up pulling money out of investment and retirement accounts to cover their spending, thus potentially foregoing investment returns they would’ve gotten had they taken Social Security early. Therefore, when we take potential investment returns into account, the decision to take Social Security early or to delay shifts.
The following table from JP Morgan Asset Management shows the optimal claiming strategy for your social security benefits based on your expected annual rate of return. The lower your expected return, the more beneficial it is to delay your claim. Conversely, the higher your expected return, the more advantageous it is to claim early. With a high enough return, a retiree is always better off claiming early as the increased benefit from waiting is smaller than the growth of the investment portfolio.
Michael Kitces, author of the Nerds Eye View Blog, calculated the real internal rate of return generated by the decision to delay social security. At the beginning of retirement, the rate of return for delaying benefits is deeply negative:
The real IRR, or return after inflation, of delaying social security turns positive in year 17. Once you move to about 25 years, the real rate of return starts becoming quite attractive for long-lived retirees.
Considering that stocks have historically returned around 7% real returns, that makes the guaranteed real return on delaying social security attractive for long-lived retirees.
The Financial Planning Association published a study utilizing historical data on stocks, bonds, and inflation to analyze two different claiming scenarios. The first scenario looked at a single individual with a $1M portfolio while the second scenario was a couple with a $3M portfolio. In both cases, they assumed they would live until 95.
The following chart shows the historical legacy wealth differential at death for the individual claiming at 70 versus 62. When the line is above 0, it means that the better outcome was delaying social security to 70. When the line is below 0, the better choice was taking social security early at 62. The study found that delaying from 62 to 70 provides larger net legacy wealth at age 95 in 76.3 percent of the historical cases for this single individual. Delaying their claim to 70 resulted in larger legacy wealth for the married couple 77.1 percent of the time.
The following chart from the study may be more striking. The chart plots legacy net worth based on taking social security early versus delaying. The data points above the line are the times when delaying benefits proved the better outcome. The lower left quadrant of the table is particularly interesting as it shows a significant number of negative legacy net worth situations for an individual who takes social security at 62. In practical terms, that means the individual ran out of money before age 95. In fact, this happened 8.5% of the time historically based on the study’s assumptions.
Thus there’s an argument to be made that delaying social security provides an insurance-like benefit that helps avoid some of the worst outcomes for long-lived retirees. In contrast, taking social security early may provide a higher return on investment, but also a higher risk of running out of money.
The flaw with the scenarios in this study is that they assume 1) Everyone lives to 95 (far exceeding the actuarial life expectancy) and 2) they assume good investing and spending behavior that many find difficult to follow in practice.
Figuring out the optimal strategy for your social security benefits is not a simple or straightforward task. It requires careful planning and analysis of your goals, preferences, and circumstances. There is no one-size-fits-all solution that works for everyone. Hopefully, the data in this post help you to make an informed decision. If you want to discuss your social security benefits or financial situation, please contact us today for a free consultation.
Scott Caufield, CFA, CPA