When to take Social Secuity

The decision of when to take Social Security benefits has a major impact in a number of areas, including survivor benefits and the tax burden that a retiree will incur. It is a very important decision, yet a complicated one, depending on many factors such as life expectancy of each spouse, the relative ages of the spouses, and the availability of alternative income sources.

In a 2004 survey, only two-fifths of respondents could venture a guess about their expected Social Security benefits and many respondents knew little about program rules; over half of current workers expect to become eligible for full Social Security benefits at younger ages than are actually feasible. Overall, households are quite uninformed about many of the key variables that should enter well-reasoned plans for when to take the benefit.

The full retirement age is slowly being increased to 67 years of age. For those retiring now, the age is 66, and benefits are reduced by a little over a half percent for each month before that age if taken early. For example, taking the benefit one year early would reduce it by six and a quarter percent. Conversely, delaying taking Social Security until after full retirement age causes the benefit to increase by 2/3 percent per month delayed, or eight percent per year. The Social Security Administration website offers a calculator that computes the 'break even' age below which it is better to take the benefit early. Unfortunately, a closer study finds the calcuator to be misleading, and the actual break even age to be only around 75 or 76 when tax considerations and investment expenses are taken into account.

Despite this relatively early break even age, there is a definite temptation to take the benefit as soon as it becomes available, at age 62. In 2005, according to the Social Security Administration, 72% of recipients of Social Security income started their benefits prior to their full retirement age. Undoubtedly, there are people who just need the money as soon as possible, but for those less pressed by circumstance, a more reasoned decision should be made.

One of the reasons behind the strong preference for receiving the benefits earlier is the fear that the system will become bankrupt and retirees will cease to receive payments. Although the funding of the Social Security system does face challenges, it is perfectly possible to keep it solvent with relatively modest changes. However, the thought that the benefits might one day cease leads some to the idea of taking them now to invest and beat the eventual amount they would receive from the system. Three things are needed for the investing strategy to work: first the markets must cooperate, secondly you must pick the right investments, and finally, you must avoid buying and selling at the wrong time. The average mutual fund investor struggles with this, as fear and greed drive behavior. Also, an individual picks up the expense of managing these dollars in the form of fees and expenses (commissions, management fees, 12B-1 fees, advisor charges, etc.). Most people won't be better off by taking the money and investing it.

Another benefit of Social Security income is that it's inflation protected. Unless purchasing a private inflation-adjusted annuity, a retiree who chooses taking Social Security early retains the inflation risk on the difference in annual income between the early Social Security amount and the delayed Social Security amount. Over a 25 year retirement at a 3% inflation rate, a dollar of income from a non-inflation protected source would only be worth 48 cents. Since the inflation adjustments to Social Security are compounding, the cumulative differences can be quite significant. Many individuals are likely not considering the impact of higher COLAs on a delayed benefit since the Social Security statement they receive does not illustrate the benefits of those higher COLAs.

These dollars that must be made up are often much less tax efficient as they usually take the form of IRA withdrawals (taxed as ordinary income). Remember, it's the after tax value you get to enjoy, as we discussed when explaining the 'Tax Torpedo' concept. Social Security is very tax efficient and this is an argument for waiting to at least the full retirement age, if not until the maximum age 70 if alternative sources of income are available.

Perhaps the most important area where Social Security has not been adequately valued is in the value of spousal and survivor benefits. Whenever a member of a married couple dies, the highest individual benefit at that point in time is the one that continues to be collected by the surviving spouse. In other words, it does not matter who dies first, the primary worker or the spouse, because the lower benefit drops off. Thus, when a primary worker delays Social Security, the higher delayed benefit plus any compounding inflation adjustments are passed on to the spouse at the primary worker’s death, if that benefit is higher than the one the spouse is currently receiving. The fact that a higher, delayed retirement benefit can be passed on at death is often overlooked in break-even calculations.

There is one situation in which we do recommend taking Social Security as early as possible. This is because the Senior Citizens’ Freedom to Work Act of 2000 allowed the primary worker to ‘file and suspend’ their benefits upon reaching their full retirement age, while continuing to accrue the 8 percent increase each year. This ability to ‘file and suspend’ benefits is an option whether or not the primary worker is still working. Most importantly, it entitles the spouse to take Social Security spousal benefits. The Senior Citizens’ Freedom to Work Act of 2000 provides more choice for the retirees and the decision on whether to collect Social Security benefits now becomes a separate one for the primary worker and the spouse in a married couple.

As you can see, the Social Security issue is complex, however the right software makes the decision easy. We have that software at Bay Area Planners to calculate your benefits at various ages so you can make the right decision of when you should take Social Security. Simply bring your latest Social Security Statement (issued annually by the SSA) to an hour-long private appointment. We will run the numbers for taking the benefit at ages 62, 66 and 70 (or whatever age you or your spouse are considering) and see how you are affected over your expected lifespan(s). You will have the opportunity  to discuss the results and ask questions. Call (408) 725-7135 or click here

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