Most personal finance experts suggest that you wait as long as possible before claiming Social Security benefits, because every year you delay (until you turn 70), your monthly benefit grows. But some investors may see an opportunity to take Social Security early: If they do, they can draw less on their equity, putting more money into their nest eggs where it can continue to grow.
It is certainly possible to get ahead by claiming Social Security early when you consider your investment returns. But for most retirees, it probably isn’t worth the risk.
A mathematical analysis
Consider this example: You are an average earner whose full retirement benefit would be $1,625 per month, and you are retiring at age 62. By claiming as soon as you qualify, they will reduce their monthly benefit by 30% to $1,138.
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Instead of using that income to pay bills or go on vacation, invest it in a special account. Each month, you buy $1,138 worth of stocks, bonds, and other assets that you believe will perform best for the next five or eight years. Ideally, this will result in a bonus portfolio that you can use during the rest of your retirement that will more than make up for the larger payments you’ve missed by not delaying taking Social Security.
Assuming an average annual cost of living adjustment of 2%, you could have claimed benefits of $1,794 per month if you had waited until age 67 to do so. That compares to the $1,256 per month you will actually accumulate by then, as your $1,138 monthly payment will also have gotten those 2% COLAs over time. Based on a safe withdrawal rate of 5.3% over 20 years, the portfolio built using those early Social Security checks must have grown in value to $121,866 to fund the $538 monthly difference. Achieving that would require a stable return of just under 20.7%.
Waiting to claim benefits until you turned 70 would have resulted in Social Security checks being $1,028 a month higher. To safely provide that much cash flow, the portfolio you funded using those Social Security checks would have had to increase to $232,784 in the intervening eight years. That would require a stable annual return of almost 16.2%.
Those are unusual results. Only about one in ten historical eight-year rolling periods has yielded an average annual return of more than 16.2%.
A case study
However, I can’t imagine anyone investing their Social Security income in a separate account. Instead, they are more likely to use the income from the program to offset how much they need to withdraw from their existing retirement portfolio.
Imagine retiring at age 62 with a $1 million retirement portfolio. You can collect your $1,625 Social Security check at full retirement age in five years, or you can start your benefits immediately and receive $1,138 per month. You have budgeted $53,650 annually for expenses and taxes. (Luckily, that adds up to 4% of $1 million, plus your 12 monthly Social Security checks.)
Again, we assume a cost of living adjustment of 2%, which is the inflation metric also used to increase their annual withdrawals. Each year, you pull enough from their retirement portfolio to make up for the difference between your budget and your Social Security income. So if you delayed Social Security, you would have to withdraw the entire $53,650 from their portfolio in that first year, but you could reduce that to just $40,000 if you claimed early.
At age 92 – 30 in retirement – to have the same portfolio value as you would if you had deferred the claim to age 70, their retirement portfolio would have had to have a consistent annual return of 7.78%.
That may sound feasible. But most retirees’ portfolios are designed to conserve capital and therefore have more conservative asset allocations, leading to less robust returns. In addition, a poor sequence of annual returns early in retirement will harm the early claimant more, requiring a higher average return to move forward.
The table below shows the portfolio value at age 92 based on various portfolio returns. It also shows how a poor sequence of returns to retire can affect the ultimate portfolio values.
|Claim at 62||Claim at 67||Claim at 70|
|5% stable return||$771,409||$904,391||$968,079|
|7% stable return||$2,754,432||$2,819,502||$2,832,901|
|7.78% stable return||$3,973,320||$3,990,975||$3,973,321|
|7.78% bad order*||$4,122,064||$4,483,862||$4,418,309|
|7% bad order**||$809,616||$1,088,240||$1,165,032|
Indeed, delaying the day you file your Social Security application offers good protection against a weak period for your investments early in your retirement, despite higher portfolio withdrawals. That’s because there’s a planned decline in admissions five to eight years after retirement.
Other Practical Considerations
The above examples ignore several real-life considerations.
A big consideration for any retiree is taxes. Taking Social Security later gives people more time to optimize their tax positions before that new income stream comes into play. Retirees need to consider things like minimum benefits requirement and capital gains, and a few years without additional income can provide opportunities to reduce those later on.
The other consideration is that retirees should err on the conservative side. Which is more important to you: maximizing your wealth at age 92, or making sure you don’t run out of money before then? Social Security offers great returns with very little risk for those waiting to collect it. While it’s possible (though unlikely in my opinion) that you can do that better with a well-designed and happy investment strategy, why take the risk? A more appropriate risk would be to adjust your asset allocation to the present value of your future Social Security benefit.
If you want to claim Social Security early to invest it, you better be confident that you can get a very good return. Even if you have to withdraw more than 4% a year from your retirement portfolio to make ends meet in those early years, it’s probably better to do that and then reduce your annual withdrawals after you claim Social Security at 70 .
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