While taking withdrawals from your portfolio to cover your expenses while you maximize your Social Security payments is an attractive alternative to purchasing an income annuity from an insurance company, I wouldn’t recommend such action to everyone. The media is currently buzzing about how you should delay taking Social Security until age 70 in order to maximize your monthly benefit. Let’s examine a fairly typical retiree and determine if it pays to postpone receiving Social Security checks.
Let’s assume our retiree is age 62 and would receive $2,000 per month in Social Security if she waits until full retirement age (age 66) to begin taking benefits. She could take benefits now and receive $1,514 per month, or wait until age 70 and receive $2,626 per month. Our analysis will assume the retiree lives to age 85, a fairly typical life expectancy. The analysis will be performed by “Social Security Income Planner” (www.ssincomeplanner.com), which charges a fee to conduct these very calculations.
Just like all the latest articles and publications suggest, the sum lifetime Social Security benefit of the individual is maximized if she waits until age 70 to begin taking benefits. While she would only receive $414,836 in lifetime benefits if she begins taking Social Security at 62 and $454,794 in benefits if she begins drawing at 66, our retiree would receive $474,582 in total benefits if she collects the larger payout at age 70.
However, this simple analysis ignores a basic rule of finance — the time value of money. What if rather than taking these Social Security payments and spending them, the retiree had the ability to invest in the market? Similarly, what if spending her Social Security payments enabled her to leave the equivalent amount of funds in her 401k, IRA, or other retirement account where it can continue to generate a return?
Let’s now assume that taking Social Security enables our 62 year old retiree to leave the benefit amount in her retirement account each month, where it generates a 5% annual return (the stock market has returned an average of about 10% per year since 1970). If she begins this process at 62, the $1,514 per month she keeps in her investment account would be worth $765,362 when she reaches age 85. Alternatively, if she waited until 70 to keep her $2,626 monthly benefit in her investment account, she would only have $704,202 at age 85.
Obviously, the higher the return achieved on the investment, the more worthwhile it becomes to take Social Security early. Yet, even with a 3.3% rate of return, our retiree would have had a larger account value if she received and invested Social Security benefits at 62 rather than at age 70. Similarly, the shorter the life span of our retiree, the more appealing it is to take benefits at age 62. However, while assuming a 5% return, the retiree’s account would be worth more even up to age 90 if she began taking benefits at age 62 as opposed to age 70.
So should everyone begin taking Social Security benefits as early as possible? Absolutely not. First, it is rarely worthwhile to begin taking benefits before full retirement age if you are still working because doing so will likely reduce your benefit. Additionally, the security of maximizing a monthly check from the U.S. government is valuable to investors with a low risk tolerance. For people unwilling to see their investment accounts ebb and flow during retirement, doing what they can to maximize their Social Security check might make sense. However, for individuals with at least an average appetite for risk, exploring the option of taking Social Security early is at least worth considering.