The decision of when to start Social Security benefits is an extremely important part of retirement planning. Equal to the importance of the issue is the complexity of the options. Due to the complexity, there is not a one-size-fits-all solution. As we often say, these sorts of decisions must be made in light of your complete financial plan – which must include a purpose that is the foundation to the plan.
That said, we have several issues we think should be considered before making the claiming decision. We hope these will help you understand the role of Social Security in your plan.
How do you view Social Security?
Many people view it as an entitlement and they are counting down the days until they get their benefit. We recommend that you view Social Security as a hedge against longevity risk. Social Security is guaranteed income that adjusts for inflation each year. By delaying your benefit, a larger amount adjusts for inflation each year going forward, which is what makes this a hedge against living for a longer time than expected…you can’t outlive Social Security, but you can outlive your investment portfolio.
“Social Security is going broke”
This rationale can be used in favor or claiming as early as possible and against using Social Security as a longevity hedge. It is true that there are structural problems, but it is very unlikely that any changes would be made to current retirees. Both political parties understand this and all recent thoughts around solving the issue focus on those who are not retired.
Retirement Age vs. Claiming Age
Retirement age is not the same as Social Security claiming age. These are two separate issues that are often linked in people’s minds. By unlinking the two decisions, there are often new opportunities that are available, such as Roth IRA conversions, that become more attractive at lower tax rates (this is achieved by not having Social Security income, which is taxable).
Know the limits of a break-even analysis. Many people will calculate a break-even analysis to determine when to file for their benefits. They have this analysis done and then consider the likelihood of living past that age based upon their health and family history. This can be prudent in some situations, but it should not overshadow the retirement plan and the longevity aspect of Social Security. Also remember, if you know exactly when you’ll die, this is a very easy decision and you could use your assets to the maximum. Since we do not know when you’ll die, betting against a break-even age that seems unattainable is not exactly a good bet. If you win the bet, you died, if you lost the bet, you have a smaller Social Security benefit.
Social Security is “actuarially fair”
This means that they benefit you’ll receive by claiming at age 62 is the same as if you claimed at 70 as long as you die according to when the life expectancy table thinks you will die. Keeping this in mind will help you give more weight to financial planning issues around claiming, such as the survivor benefit for your spouse.
Understand the taxation of benefits
Many people take their Social Security benefit at age 62 in order to get their “free money”. Often, they are not ready to retire and continue working. If this is your plan, have you thought about the taxation of your benefits? Are you aware that Social Security withholds benefits if a beneficiary has not yet attained the full retirement age and earning exceed the “earnings test exempt amount”?
There are certainly situations where claiming Social Security before your full retirement age can make sense. That said, waiting until full retirement age or beyond to age 70 can often benefit your overall retirement plan and increase the longevity of your portfolio. There are numerous issues not mentioned here that can change this on a case by case basis including survivor benefits, divorced spouse benefits, other pensions, etc. Before claiming, a consultation with a retirement planning specialist can prevent unintended consequences. When you know what age you want to claim, read this to learn when and how to apply for benefits.
The information herein is general in nature and should not be considered advice.