If you’re evaluating when you take Social Security you might be asking yourself this:
By waiting to take Social Security, I’ll get a larger benefit. But while I’m waiting, I’ll have to withdraw more from my retirement savings, which means I’ll miss out on the investment gains those larger withdrawals would have earned. Am I really better off by waiting for a bigger Social Security check?
Ok, let’s tackle this great question.
The Benefit of Waiting
First off, the later you apply for retirement payments, up to age 70, the higher they’ll be for the rest of your life. If you live to at least an average life expectancy you’ll be better off waiting.
Here’s exactly the benefit you receive by waiting:
You’ll get an extra 2/3 of 1% for each month you delay after your birthday month, adding up to 8% for each full year you wait until age 70. Keep in mind this doesn’t include cost of living adjustments that Social Security provides each year. So tack on another 1-3% boost.
And the higher payments might continue even longer, for your spouse after you pass away. If you are married, your spouse may receive widow(er)’s benefits after you pass away, for the rest of his or her life. Widow(er)’s benefits are the greater amount between you and your spouse’s Social Security.
For example: you receive benefits of $2,000. Your spouse receives $1,500. If you were to die, then your spouse would receive $2,000 (widow’s benefit) even though their benefit was only $1,500.
We’ve seen that you get an 8% boost plus inflation for each year that you delay and if you were to pass away that benefit stays with your surviving spouse.
Now, let’s talk about the next factor that matters in this decision.
How long you live plays a major role in the timing of when to take Social Security. In short, if you’re expected to die sooner, then take your Social Security benefits sooner. If your life expectancy is longer, then you should try to delay Social Security for as long as you can.
Steve Vernon, an actuary, wrote an article for CBS News on ‘How to Maximize Your Social Security Payouts.’ He performed the analysis on when you should take benefits if you’re just looking at life expectancy.
Here is the summary for an individual:
- File at 62 if you expect to live only to age 70
- File at 66 if you expect to live to between 71-80
- File at 70 if you expect to live beyond 81
Furthermore, if you are a member of a couple, you should know that joint life expectancy – the median age at the second death – is longer than individual life expectancy. For example, the IRS estimates 21 remaining years of life for a 65-year-old individual, but 26.2 years for a 65-year-old couple (IRS tables). That’s age 91 for the longer-living spouse.
Remember, your spouse will receive the widow(er)’s benefits after you pass away, for the rest of his or her life.
So if you are in this position (married couple of at least age 65 and in average health), then you should look very seriously at delaying the higher earner’s Social Security until age 70.
If you’d like to get a more personal estimate of your life expectancy (since you don’t want the government determining when you’re going to die 😉 ), you can estimate your life expectancy at the website: www.livingto100.com.
Replacement Cost and Lost Compounding
After the last points above, you’ve probably reached the conclusion that you should delay for as long as possible.
Now we’ll evaluate if you can. We’ll do a straightforward analysis to see if taking withdrawals is worth the loss of compound growth.
It is very tempting to just take the Social Security money since it is staring you right in the face rather than use your IRA account to replace your Social Security payments. Hopefully, this exercise will allow you to consider all the alternatives.
First step: compute how much it would cost to use your savings to replace your Social Security payments.
Let’s say, your FRA (Full Retirement Age) benefit at 66 is $1,600 per month. If you delayed until 70, your benefit would be $2,112 (132% of $1,600).
To get from 66 to 70 would cost you $76,800 ($1,600 x 48 months). This is money you’d have to spend from your IRA account to “bridge” the income gap between 66 and 70. This is a substantial amount of money, but if you can set aside this amount, you can earn a guaranteed 8% increase in monthly cash in your bank account (Do not confuse this with an 8% investment return).
We like to spend a lot of time talking about investment returns, but once you retire and you start spending from your portfolio, the only thing that matters is how we prudently maximize the monthly deposit into your bank account. This is why the 8% increase in Social Security is not the same as an 8% investment return. Keep reading.
Now let’s see if the lost compounding on the $76,800 we used to bridge our income was a good call or not.
The difference in Social Security income from age 66 to 70 is $512 ($2,112 – $1,600). If we annualize this, we get $6,144 of income that our $76,800 will need to grow to in order to produce and sustain this amount. To illustrate, let’s use the 4% initial withdrawal rule.
Using the 4% rule, you need a portfolio of $153,600 to generate the additional $6,144 (6,144/0.04) [Note that these amounts are in current dollars — the totals haven’t been adjusted for the time value of money or to reflect future cost-of-living adjustments. Adding these refinements in the calculations only complicates matters but doesn’t change the main conclusions].
Now let’s see if the $76,800 can compound to $153,600 in 4 years. In order for that to be the case, you would have to earn a return of 18.9% each year.
You can ask yourself if that’s a possible return to earn, but I’ll just tell you that it is vastly unrealistic.
The point I’m trying to make is that compound growth does nothing for you until you turn it into income (aka monthly cash in your bank account). And to turn it into income, you can’t just rely on an average rate of return to determine your withdrawal rate. You have to factor in sequence of returns (have bad returns at the beginning of your retirement) and inflation risk, which is why the percentage you can sustainably withdraw is much lower than the return you may earn.
Again, cash in the bank is not the same as returns on a statement.
How to Determine if You Can Afford to Delay
If you have more than the computed Social Security replacement cost (in our example it’s the $76,800) in your IRA plus money in your savings account for emergencies, then it might make sense to delay until 70.
How much more?
That depends, of course, on your situation. Did you want your IRA money to be an inheritance to your children? Were you planning on using the funds for another purpose like paying off a mortgage or making a large purchase?
If you have multiple hundreds of thousands or millions of dollars saved, then you should seriously consider delaying Social Security until 70 and using some of that IRA money.
This next statement might be the most important thing I say: While the analysis above is nice, this determination is more psychological than financial.
Once people are eligible for full Social Security benefits, people want that money. Why would you give that up?
Some helpful practical steps to keep you thinking logically:
- It’s very likely that you will live to 90 or 100 years old. What do you think your 100-year-old self would have liked you to have chosen?
- Would it make a difference if that money was set aside in a different account earmarked for bridging the income gap until 70? If so, you can open a completely separate account and know that this money is just for that purpose.