20 Sep Social Security: Pay Me Now or Pay Me Later
Contrary to the common approach of taking Social Security early, I’ve found that after running hundreds of financial plans, it’s often best to wait.
The primary reasons people start early is the assumption they can earn better returns than the government or believe they might as well take what they can before entitlement reform kicks in. While this is reasonable, the decision to take benefits early comes with steep lifetime benefit cuts that increases their risk of outliving their money. This is further complicated by increasing life expectancies due to medical advancements. By transferring more of the longevity risk to the government, retirees may find they can go into their later years with more confidence.
Most pundits believe social security reforms will focus on younger workers and won’t impact people who are near or in retirement. Anything is possible but this makes sense due to the political difficulties of reducing benefits on this influential voting bloc. One reason high net worth individuals might take benefits early is the risk they could be “means tested” in the future. However, the potential benefit of starting early if this happened may not provide enough reward to offset the permanently reduced benefits that come with this decision.
With all this in mind, I’ll touch on three potential mistakes I see retirees make:
1) Taking Benefits Too Early. 70% of retirees take benefits earlier than their normal retirement age. Age 62 is the earliest you can start and the lifetime benefit reduction is 25%. One rationale for taking early is you can earn returns on the money you receive; pushing the break-even age (compared with waiting) to the early 80’s if you do well. What happens if you live past 80? The life expectancy of a 62 year old female is 86.
2) Not Considering Joint Life Expectancy. Upon death, the surviving spouse’s benefit (if lower) jumps to the deceased spouses benefit. If the husband has a higher benefit, there is a real planning opportunity due to lower male life expectancy. The husband can wait until 70 to take benefits and receive 32% more compared to starting at 66, while his bride can start her benefits at 62. If the husband dies first, she can step up to his higher benefit for the rest of her life. This is especially powerful if the husband is older than his wife.
3) Triggering the “Earnings Penalty.” You temporarily lose $1 of benefit for every $2 of “earned income” over $14,160 if you take benefits before full retirement age, which can be a bad cash flow surprise. You eventually get this back but it isn’t worth the rigmarole and tax headache. If you are working part time after you retire from your full time job, it’s best to wait until full retirement age to start Social Security.
From a planning perspective, it’s good to look at scenarios assuming full and reduced benefits to see the implications. The best age to start is unique to each retiree’s situation and depends on health and a host of other factors. If you have recently signed up and want to reconsider, the good news is you can change your mind within the first twelve months.
Due to the fact this is a very complex area, please don’t hesitate to contact me if you have additional questions.