By Peter C. Golotko, CPA/PFS, MBA
What is your strategy to begin receiving Social Security benefits? Are you married or single? How is your health? Your spouse’s health? Your parents’ health history? Before receiving Social Security benefits, each individual has to make the decision whether to start collecting benefits in the first year of eligibility at age 62, wait until age 70 when you could qualify for the maximum payment based on your salary history, or start collecting somewhere in between. Every situation will be different, and each individual should take into consideration their unique factors when making their decision. While it may be favorable for some individuals to delay their Social Security, below we will explain how not delaying benefits may actually be in your favor.
For individuals looking at their own benefits (versus looking at their benefits and their spouse as a single household), a person with an average life expectancy can easily gain more from taking benefits early even after an adjustment for inflation and time value of money. For couples looking to receive benefits, the math gets complicated.
Delaying benefit payments for couples to generate a higher benefit down the road only works if both spouses have similar benefit values. When one spouse has a higher benefit, delaying that higher benefit does actually work because the delayed “8% premium” overcompensates for the current smaller benefit. In that situation, it is highly recommended for the larger benefit spouse to delay as long as possible but allow the lower benefit spouse to begin receiving benefits as early as possible. The caveat is that both spouses must live well into their 90s to pass the breakeven point of receiving benefits at retirement age.
Let’s run through an example to show how this conclusion. Eric is eligible for a $24,000 annual benefit at full retirement age of 66. Eric decides to delay his benefit to age 70 (four years from now) thus boosting his annual benefit by 32% to $31,680. However, in reality, his benefits will be slightly higher due to four years’ worth of cost of living adjustments (COLA). Due to COLA, Eric will actually receive an additional $7,680 annually. The lost benefit for taking at full retirement age rather than at age 70 is $15,360. From this calculation, delaying seems to be worth the wait, but is it?
Most people talk about the “8% premium” received each year they delay benefits, but few fully understand its implications. In reality, the premium is meaningless if people don’t have other cash flow to pay ongoing living expenses. Assuming a 3% inflation rate and moderate rate of return of 6% to invest those benefits, delaying benefits for four years from age 66 to age 70 would take 21 years (age 87) to break even on the delay “return.” Again, living into your 90s is the only way to beat that system, but few actually do.
The same could be said for taking benefits early at age 62 where benefits are reduced by 25% of the full retirement age amount. This in itself is another break-even strategy that may only work assuming poor health. Taking benefits at 62 rather than full retirement may benefit you financially assuming a shorter life expectancy.
It seems to pay not to delay unless one member has a substantially higher benefit than the other and both live a long and healthy life. In theory, we all think that life will continue and that we will all live longer than expected. However, the chances that both spouses will live into their 90s, as per the break-even scenario, is far from reality. Studies show that only 10% of couples will live into their 90s! The drop off for individuals is far more significant.
The decision to delay benefits must still be evaluated based on your personal situation including cash flow, potential estate tax, life expectancy, health of the individuals, and health history of the family. Deferment, start/stop plans, and spousal benefit percentages may come into play. It’s best to speak with your trusted advisor about your specific circumstances.
Source: Michael Kitces