Knowing When Not to Delay Social Security

Most people don’t delay Social Security retirement benefits. They begin benefits as soon as they are able to at age 62 or shortly thereafter. That’s one reason why I frequently explain the advantages of delaying benefits for at least one spouse in a married couple.

Yet, there are two sides to this issue. There are good reasons for some people to begin taking benefits early.

About 37.5% of men and 42.4% of women claim their retirement benefits at age 62, according to the 2013 Social Security Administration’s Annual Statistical Supplement. Even so, more people are delaying benefits than used to, because 10 years ago about 50% claimed benefits at 62. About 31.5% of men and 25.2% of women now wait until their full retirement age to claim benefits. Far fewer than 10% wait until age 70, when benefits are maximized, and that number’s held steady for decades.

The prime reason to begin taking retirement benefits early is that you need the income. Perhaps you’ve retired, lost your job, or had your hours reduced. Many people don’t have enough savings to finance a long retirement or to completely fund living expenses from age 62 to 70 so they can wait for maximum retirement benefits.

Or they don’t want to tap their savings. Some want a nest egg to be available for emergencies or to leave to loved ones, if possible. So they start Social Security as soon as possible.

Another reason to begin Social Security retirement benefits early is you don’t believe you’ll gain from delaying benefits.

You have to live for a while to make delaying benefits pay off. If you delay benefits and pass away soon after they start or even before receiving any benefits, you’ve suffered a loss. The breakeven age for delaying benefits is around age 81 by most estimates. You have to live to at least 81 to receive the same lifetime income from delaying benefits to 70 as you would by beginning at age 62. Live longer than 81 and you come out ahead.

Some people take benefits early because they haven’t consulted life expectancy tables and don’t realize what their average life expectancy is and that the probability of living to the break even age or beyond is high.

But others have reasons to believe they won’t live to the average life expectancy or beyond. When life expectancy for an age group is 81, that means half the group won’t live that long. Some people examine their family history, personal health, and perhaps other factors, and conclude that they aren’t likely to gain from delaying benefits.

Another reason people give for taking benefits early is the financial condition of Social Security. They believe that with Social Security projected to run out of money in the early 2030s they should take benefits early before they are reduced or eliminated.

There’s no doubt that changes will have to be made in Social Security for it to keep paying promised benefits. But it’s important to analyze the situation correctly.

The “trust fund” behind Social Security is expected to run out of money around 2033, according to the latest Annual Report of the Trustees of Social Security and Medicare. But that’s not the whole picture. The Social Security payroll taxes will continue to be collected each year. The Trustees’ annual report regularly estimates that those taxes will pay 70% to 75% of promised benefits indefinitely.

The worst case scenario would be that nothing is done to change Social Security and the trust fund is depleted around 2033. At that point, the benefits wouldn’t be eliminated. Instead, a gap of about 25% would have to be closed. I don’t think the benefit reduction would be across-the-board. Instead, there likely will be increased means-testing in which people who earned higher incomes during their working years would have some of their benefits reduced. Or payroll taxes would be increased to cover the shortfall. Other possible changes include a reduction in the cost of living increases and an increase in penalties for those who receive earned income and retirement benefits at the same time. Most likely a combination of these changes would occur. And most people who are receiving benefits or are near that point likely would be protected.

I don’t see the precarious financial condition of Social Security as a reason for most people to take benefits early. It might be one factor to tip the balance if there are other reasons to lean toward early benefits. But very few people who are near benefits age when the trust fund runs out will see benefit reductions.

Some people say they take benefits early because they plan to invest them to earn higher returns (or to avoid spending down current investments). They believe this will result in more lifetime wealth than waiting for higher retirement benefits.

There are a few factors to keep in mind when analyzing that decision.

Social Security retirement benefits increase about 8% annually for each year you delay them. In addition, for most people those benefits are entirely or mostly free of income taxes. So, your investments have to earn more than 8% after taxes to match what you’d receive by delaying benefits.

Also, the increase in retirement benefits is guaranteed, while the returns on your investments aren’t, except for a few insurance policies. You might or might not be able to achieve high enough returns to match or beat the increase you’d receive from Social Security.

A final factor to consider is your spouse. Social Security retirement benefits are a form of life insurance. In married couples, after one spouse passes away, the surviving spouse receives the higher of the two benefits each of the spouses was receiving or entitled to.

Consider a married couple in which one spouse has good reason to expect he or she wouldn’t survive to life expectancy. Suppose that spouse had higher lifetime earnings and therefore is entitled to higher Social Security benefits than the other spouse. It might make sense for that spouse to delay benefits so that the surviving spouse will receive higher benefits for the rest of his or her life than would be the case if the first spouse took benefits early.

There can be good reasons to begin Social Security retirement benefits early. Before making a decision, try to examine the issue from all angles. If you decide to delay benefits, re-examine that decision every year or so in case circumstances change.

RW October 2014.