Most personal finance experts suggest that you wait as long as possible to claim Social Security benefits because each year you delay (until you turn 70), the more your monthly benefit increases. But some investors may see an opportunity in taking Social Security early: It would allow them to draw less on their own assets, leaving more money invested in their nest eggs where they can continue to grow.
It is certainly possible to come out on top by claiming Social Security early by considering your returns on investment. But for most retirees, it’s probably not worth the risk.
A mathematical analysis
Consider this example: you are an average earner whose full retirement age benefit would be $1,625 per month and you retire at age 62. By claiming as soon as you are entitled, they reduced their monthly benefit by 30% to $1,138.
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Instead of using this income to pay bills or go on vacation, you invest it in a special account. Each month, you buy $1,138 worth of stocks, bonds, and whatever other asset you think will perform best over the next five or eight years. Ideally, this will result in a bonus portfolio you can draw on throughout your retirement that will more than compensate for the larger payments you missed by not waiting to take Social Security.
Assuming an average 2% annual cost-of-living adjustment, you could have claimed a benefit of $1,794 per month if you had waited until age 67 to do so. This compares to the $1,256 per month you’ll actually collect by then, because your monthly payment of $1,138 will also have earned that 2% COLA over time. Assuming a safe withdrawal rate of 5.3% for 20 years, the portfolio built using those first Social Security checks would need to have reached $121,866 to fund the monthly difference of $538. Achieving this would require a steady return of just under 20.7%.
Waiting to claim benefits until you hit age 70 would have resulted in higher Social Security checks of $1,028 per month. In order to safely provide so much liquidity, the portfolio you funded with those Social Security checks would have had to grow to $232,784 over the past eight years. This would require a steady annual return of almost 16.2%.
These are unusual results. Only about one in ten historical eight-year trailing periods have produced average annualized returns above 16.2%.
A case study
However, I can’t imagine anyone actually investing their Social Security earnings in a separate account. Instead, they are more likely to use program income to offset the amount they need to withdraw from their existing retirement portfolio.
Imagine retiring at age 62 with a retirement portfolio of $1 million. You can collect your Social Security check for $1,625 at full retirement age in five years, or you can start collecting your benefits immediately and collect $1,138 a month. You have budgeted $53,650 per year for expenses and taxes. (Conveniently, that equals 4% of $1 million, plus your 12 monthly Social Security checks.)
Again, we will assume a cost of living adjustment of 2%, which is the measure of inflation used to also increase their annual withdrawals. Each year, you withdraw enough from his retirement portfolio to make up the difference between your budget and your Social Security income. So if you delay Social Security, you would have to withdraw the entire $53,650 from their wallet in that first year, but you could reduce that to just $40,000 if you claimed early.
At age 92 – 30 years post-retirement – for you to have the same portfolio value as if you had delayed applying until age 70, their retirement portfolio would need to have produced consistent annualized returns of 7.78%.
It may seem achievable. But most retiree portfolios are designed to preserve capital and therefore have more conservative asset allocations, leading to less robust returns. Additionally, a poor streak of annual returns early in their retirement will hurt early claimants more, requiring a higher average return for them to come out on top.
The table below shows the value of the portfolio at age 92 based on various portfolio yields. It also shows how a poor sequence of returns in early retirement can affect final portfolio values.
|Claim at 62||Claim at 67||Claim at 70|
|5% regular returns||$771,409||$904,391||$968,079|
|7% regular returns||$2,754,432||$2,819,502||$2,832,901|
|7.78% regular returns||$3,973,320||$3,990,975||$3,973,321|
|7.78% bad sequence*||$4,122,064||$4,483,862||$4,418,309|
|7% bad sequence**||$809,616||$1,088,240||$1,165,032|
Indeed, delaying the day of the declaration to Social Security makes it possible to protect yourself against a period of weakness of your investments at the start of retirement despite higher portfolio deductions. This is because there is an expected decrease in withdrawals five to eight years after retirement.
Other real-life considerations
The examples above ignore several real-life considerations.
A big consideration for any retiree is taxes. Taking Social Security later gives people more time to optimize their tax situation before this new stream of income enters the equation. Retirees should be aware of things like required minimum distributions and capital gains, and a few years of no additional income can provide opportunities to reduce these later.
The other consideration is that retirees should err on the side of caution. Which is more important to you: maximizing your net worth at age 92 or making sure you don’t run out of money by then? Social Security offers great returns with very little risk to those waiting to collect it. While it is possible (although unlikely, in my opinion) to surpass this with a well-designed and lucky investment strategy, why take the risk? A more appropriate risk would be to adjust your asset allocation to include the present value of your future Social Security benefits.
If you want to claim Social Security early just to invest it, you better have great confidence that you will be able to produce very good returns. Even if you need to withdraw more than 4% a year from your retirement portfolio to make ends meet for those early years, you’re probably better off doing that and then reducing your annual withdrawals after you claim Social Security at age 70.
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