Hey guys, Mike Frontera here, back with another Retirement Theory video. You know, one of the largest decisions we face in retirement is when to claim Social Security. For a number of years now, conventional wisdom has advised to delay those benefits as long as possible. Up to age 70.
I myself have made similar assertions to clients and have made the case for delaying your claim in previous blogs.
And though I’m certainly not giving up that notion now, I would like to temper the enthusiasm around it. I’m going to do that first by debunking a widely-held myth about delaying Social Security. And then I’d like to highlight circumstances where it could make more sense to claim early rather than wait.
Ok, let’s get to that myth. The biggest myth that I hear about delaying Social Security is that your benefits increase each year by a guaranteed 8% from age 62 to age 70. It’s a reason that I’ve heard given countless times about why you should wait to claim benefits. But it’s just not accurate.
Well, maybe I’m putting it the wrong way. The math is pretty close. They do average close to an 8% increase each year. Here, let’s look at an example.
Here’s someone who is born between 1943 and 1954. Their full retirement age is 66. If they claim at 62, they only get 75% of their benefit. If they wait until 70, they get 132% of their benefit. Doing some fancy compound interest math, I get that from ages 62 to 66 the benefit increases on average by 7.46%. And across all 8 years from 62 to 70, the benefit increases by an average of 7.32% per year. If you run those numbers for someone born in 1960 or later, who’s full retirement age is 67, the math is very similar. So what’s the problem?
The problem is that no one is accounting for the fact every year you wait for benefits, it is one less year that you will claim benefits. Guaranteed. I’ll say that again. Every year you wait for benefits, it is one less year that you will collect benefits. Doesn’t matter how long you live, you can never get those missed benefits back. So now, let’s revise our math to fit the reality of the situation.
Ok in this example, at their full retirement age they’ll receive $1000 per month. At age 68, they get $1080. Let’s strip out the cost of living adjustments to make it easy. And it doesn’t change the math anyway. First, it’s clear the math checks out about the 8% raise that most people note, as $1080 is clearly 8% more than $1000. However, depending on how long you live, your total benefits received is never going to be 8% higher over your lifetime.
Let’s assume you live to be 85. That’s 18 years of $12,000 starting at age 67 versus 17 years of $12,960 starting at age 68. The total increase in benefits there just 2%. Let’s go out another 10 years to age 95. Total increase in received benefits there- 4.14%. So yes, you have cases where you have a normal to long life span, delaying benefits will ultimately increase what you receive. It’s just not as big of an increase as what's often quoted.
Why is this so close? Well in reality, Social Security has tried to make the various claiming ages actuarily equivalent. Meaning on average they’re expecting to pay out the same amount of total lifetime benefits, whether you claim early or claim late. Some people will live a long time and will benefit greatly by delaying benefits and some will live a shorter life and might’ve collected more if they claimed earlier.
This brings me to the point from the beginning of this video- which is, when would it make the most sense to make an early Social Security claim. There are a few times when you’d especially want to consider an early claim. The first of those of course is when you’re retired and you need the money. If you can’t bridge the years between retirement and a delayed Social Security claim, you might not have a choice but to claim early. The next, as I just mentioned before, is if you have a shorter life-expectancy. If you don’t expect to be around to reap the rewards of delaying your benefits, then clearly you’d want to consider receiving them as early as possible. The big caveat to that however, would be if your spouse expects to receive benefits based on your record when you pass away. So in cases where your benefits are higher than your spouse’s, your claiming age will have a major effect on how much your spouse will ultimately receive as a survivor.
And that ties into a third scenario to consider receiving benefits early. That is, if you’re single. Especially if you don’t plan on marrying again. Now we know we’re only worried about your life expectancy and the benefits for delaying are diminished.
Finally, and again I worry about opening up another can of worms here, but it’s worth tying into this video. That is, if you have low taxable income, specifically low provisional income. Provisional income is the calculation that determines your taxation on Social Security benefits. It’s beyond the scope of this video, so let’s just look at this very conceptually.
Imagine if you could receive your Social Security benefits tax-free for 8 years from 62 to 70 and you saved all of those benefits somewhereelse . You invested it. Had you delayed until age 70, which happens to be right around the time your required minimum distributions from your IRAs, you may very well have up to 85% of your benefits taxed. That is the highest portion of your benefits that can be taxed by the way.
Thinking back to all of those calculations that we looked at before, and now we look at what we actually netted out after taxes out of your benefits. Can you see that getting a number of years of tax-free benefits could make it even more attractive to take benefits earlier. It would theoretically push out that “break even” point of where you would have received more by waiting and might just tip an early claim in your favor.
Wow. Lots of interesting concepts to think about. It’s why it’s so important that you have your specific situation properly analyzed to see that you’re making the claim that is right for your particular situation. You can see that the conventional wisdom or rule of thumb often can be pretty far off.
So, do you have questions for me? Let me know. Give me a call at (518) 469-8152 or just visit me at www.retirementtheory.com. Click subscribe on your video too and see new retirement videos as they come out. Do you follow me on Facebook? I think that you should. You’ll see videos like these and get blog and article shares on everything retirement planning.
Once again, thank you for joining me. See you next time!