The decision about when to claim Social Security is the single most important decision for many people staring down retirement.
And even those from whom it’s not the most important decision, they want to get it right. They want to know how to properly think about it.
In my opinion, far more retirees and pre-retirees should consider delaying their Social Security benefit as long as possible, even all the way to age 70.
Let me tell you why…
People delay their benefits? Why?
First, why would anyone delay their Social Security benefit in the first place? Because each month you choose to delay and not collect your benefit, you are rewarded with a slightly higher benefit when you eventually do collect.
By how much? Your benefit grows by 8% for every year that you delay, up to age 70. For the rest of your life (and your spouse’s life if your benefit is greater than theirs).
Meet the “breakeven analysis”
The breakeven analysis seeks to determine the age at which the accumulated value of extra benefits you could get from delaying exceeds the accumulated value of early benefits you could bank by not delaying.
This analysis is the default question that most people ask when faced with this decision. Said differently, “How long do I have to live in order for delaying Social Security to have been the right choice?” Do I think I’m going to live that long? If not, or if I’m not sure, better not delay, because then I’ve left benefits on the table. I’ve lost.
It’s understandable to approach the Social Security question this way. People have been paying into Social Security their whole lives and want to maximize the amount they receive back from the program.
It also seems like an impassive, unemotional approach to the question. Look, I just want to do what the numbers say. What’s the right decision according to math? I want to do that.
Breakeven analysis is the wrong question
There are a couple reasons why I think this is the wrong question to ask related to your Social Security benefits.
First, it can’t serve as a purely mathematical approach to the question. Why? Because there’s an enormous variable present in the equation that is unknowable: the age at which you will die.
Sure, you can use a general life expectancy for your age and gender, maybe even craft a personalized one using your health and family history, and that will be a pretty good estimate, but the fact remains that it’s still an unknown variable. Any number of factors can cause your mortality to vary dramatically from your estimate.
The takeaway here is that when making the Social Security claiming decision, you’ve left the realm of known, quantifiable inputs. You’re in the realm of the unknown and unknowable. The best thing to do is to identify the relevant risks and use what tools you have to address those risks.
That brings me to the second reason the breakeven question is the wrong one to ask—it doesn’t identify the most relevant risk.
The breakeven question addresses the risk that you won’t have gotten as much out of Social Security as you should have. Specifically, if you die early before your breakeven date, you will have left benefits on the table, that you made the wrong choice, that you should have claimed earlier.
(For one thing, if you’re married and your surviving spouse will inherit your benefit, that may not even be true yet!)
The issue is that that risk is not the most relevant one to this question. The most relevant risk is called longevity risk—the risk that you will live a very long life and have many years of retirement that you need to pay for.
It seems counterintuitive to think of long life as a risk, but financially speaking, it’s true. Dying early before your breakeven age won’t put a strain on your resources. Living long will.
This is the most relevant risk. It’s the one that you will actually be alive to suffer through, potentially having to make large and uncomfortable changes to your lifestyle if you don’t plan for it well.
My final point here isn’t a reason so much as an observation specifically pertaining to married couples. When asking the breakeven analysis question, most people think only of the odds that the spouse with the greater benefit will reach their breakeven age, ignoring the impact of the other spouse. In truth, if either spouse reaches the breakeven age, then delaying Social Security will likely have paid off. And the odds of that happening are much greater.
The right question— “Do I need to address longevity risk?”
As mentioned above, longevity risk is the risk of living a long time and outliving your assets, or at least being forced to make major standard-of-living changes.
For some, the answer to this question truly might be no, you don’t need to worry about it. If you have enough assets that you can comfortably maintain your desired standard of living, this isn’t the most important risk for you to address.
For everyone else, the answer to this question is an emphatic yes! This is absolutely a risk that needs to be addressed. And it just so happens that there’s one tool that’s perfectly crafted for this job.
Social Security is the best way to address longevity risk
At its best, Social Security is used as a tool to address longevity risk.
The program was first created with the goal of keeping seniors out of extreme poverty. And for all its warts, it’s been wildly successful in that endeavor. Primarily because of the income it provides to those who live much longer than their life expectancy.
The features of your Social Security benefit make it perfectly suited for this job:
- Lifetime Annuity. Social Security pays you an income stream for as long as you are alive, whether that’s 85, 95, or 105
- Inflation Adjusted. Social Security increases the amount of that income stream every year, in line with inflation, as measured by the Consumer Price Index
- Survivor’s Benefit. Social Security allows your surviving spouse to inherit your benefit when you pass away if it’s greater than their own benefit and receive that greater benefit for the rest of their life
There’s an easy way to tell that delaying your Social Security benefit is a great deal—try to replicate it by buying a comparable product on the open market.
You would do this by finding an annuity, one that grows with inflation, equal to the amount of the increase you get by delaying, then comparing the cost of that annuity to the present value cost of delaying your Social Security benefit. Spoiler alert—the annuity is going to be far more expensive.
There are non-financial benefits too
On a different note, Social Security is a form of guaranteed income. Much research has shown that retirees with greater amounts of guaranteed income are more satisfied, worry less, and show fewer signs of depression.
One of the best things that “current you” can do for “future you” is to give him/her an increased amount of guaranteed lifetime income to help mitigate those anxieties.
I’m convinced. Now how do I replace the income I’m giving up?
Obviously, making the decision to delay your Social Security benefit creates a problem. The income you would have been getting from claiming your benefit now won’t be coming for a few years. How do you replace it?
First, it’s important to remember that this replacement income is not permanent. It only needs to be there for a limited time. So, whichever route you choose, there is a known finish line. This period of time between when you delay your benefits and when you eventually collect is known as the “delay period” or “bridge period”.
So, how do you replace your Social Security income during the delay period? There are a few ways:
- Continue Working. Before you skip to the next option, hear me out. From a financial perspective, the best solution is to simply continue working at your current pace/pay. This allows you to maintain your lifestyle without drawing down assets, all the while allowing your superpowered Social Security annuity to grow. In fact, working longer usually provides a boost to your Social Security benefit in a second way—through its impact on your wage history. So, if you can stomach the idea of working longer, these benefits can provide some extra motivation knowing that you’re beefing up your retirement durability.
- Go part-time. If staying at your current job or your current pace is not appealing to you, working part-time could provide enough income to replace your delayed benefit. Some may have the option to find part-time or consulting work at your current job, or in your current industry, as a way to leverage your experience and expertise, but on your own terms. For others, it may be refreshing to consider part-time work that’s totally different from your career, perhaps something that aligns with your interests or hobbies.
- Use your assets. Some of you may be at the point where you’re saying, “If the choice is between working longer in any capacity or having a smaller Social Security benefit, give me the smaller benefit, longevity risk be damned!” Thankfully, in most cases, those aren't your only options. Another option is using your assets, which can look a few different ways. One way is to use a portion of assets to purchase a fixed income stream to cover the income gap during the delay period. Products such as a MYGA (multi-year guaranteed annuity), a standard fixed annuity, or laddered bonds or CDs would all be good candidates for this as they provide guaranteed income and interest over a set period of time. Exactly what you need. Another way is to simply increase the amount you’re taking in withdrawals from your portfolio during the delay period, with the plan to reduce those back down after your Social Security benefit kicks in. In either case, it likely involves repositioning your portfolio’s asset allocation. Funds that you plan to use to cover the income gap of the delay period have a different risk situation than the rest of your portfolio, meaning that your overall portfolio likely should get more conservative. But that may not be such a bad thing. Bringing your portfolio to its most conservative when you begin taking withdrawals is one way to mitigate the sequence of return risk. So, in setting aside a portion of your portfolio for current income, you are simultaneously hedging another risk!
Like many things, the devil’s in the details here. Whether or not you should delay Social Security is dependent on your specific facts and circumstances.
By no means am I suggesting that it’s the right decision for everyone. What I am saying is that far more people should seriously consider delaying—even all the way to age 70. You have a tool in your toolbelt that’s uniquely crafted for a specific purpose. It’s wise to think hard before concluding you don’t need to use it for that purpose.
If you’re interested in discussing how this might apply to you, give us a call!