Consider Delaying Social Security Benefits

by David John Marotta
June 7, 2007

Over seven out of every 10 Americans opt to receive their Social Security checks as soon as possible. This is usually a mistake. By delaying when you start receiving your benefits, you may receive more money and ensure you have a better retirement in the long run.

Part of the confusion about timing Social Security benefits stems from the fact that full retirement age isn't the same for everyone. For Americans born between 1943 and 1954 full retirement age is 66. For everyone born before or after those dates, the full retirement age is set on a sliding scale between age 65 and 67.

You can wait until your full retirement age to begin benefits, or you can opt to receive benefits as early as age 62 or as late as age 70. Most people decide to take the cash early and run. By taking Social Security at age 62, your monthly benefit is locked in at a much lower payout rate, forever.

Waiting for the higher payout is like buying longevity insurance. However, if you wait until age 70, you will receive your full monthly benefit plus additional money for being patient. After age 70, there's no additional benefit increase, so there's no point in delaying benefits any further. The bottom line: the longer you wait, up to age 70, the higher your monthly benefit.

According to the Social Security Administration, it doesn't matter which option you choose. But, the numbers tell a different story.

When it comes to timing your Social Security benefits, delayed gratification does pay off. For retirees born in 1943 or later, benefits increase by 8 percent for each year you delay receiving your benefit. In addition to the 8 percent increase in benefits, your actual payment will also be indexed for inflation! In other words, if inflation is running at 3 percent, your actual benefit amount will increase by an impressive 11percent for each year you delay taking the benefit!

This still doesn't answer the big question: Is it better to get a smaller payout for a longer period of time or a bigger payout for a shorter amount of time? As a rule of thumb, the longer you expect to live, the more likely the later payout will pay off.

Let's consider an example. Triplets Peter, Paul, and Mary, born in 1941, are presented with identical benefit options. Each can opt for a monthly benefit of $758 at 62. They can wait until full retirement age of 65 years and 8 months for a benefit of $1,000. Or, they can delay benefits until age 70 and receive $1,312 per month.

Peter couldn't pass up the opportunity to take the earliest possible payout. He locked in his payout at $758 beginning at age 62. Paul decided to wait until his full retirement age (65 and 8 months) to receive his $1,000 monthly check. Mary decided to wait until age 70 to get a monthly benefit of $1,312.

And although Peter was the first to begin collecting his money, he didn't end up with the biggest total payout. By the triplets' 78th birthday, Paul's benefits had surpassed the total payout Peter had received. And although Mary didn't begin receiving her checks until age 70, soon after the triplets' 83rd birthday, the total value of Mary's benefits had outstripped both of her brothers'.

Upon the triplets' death at age 90, Peter had received $254,688 in total benefits. Paul had received $291,000, and Mary had received $316,192.

In other words, the longer you expect to live, the better off you'll be opting for the age 70 payout. But, does that mean you should spend down your savings, waiting for the bigger benefit?

The best plan is to keep working until age 70. That way, you can both delay taking benefits and avoid tapping into your savings. If you are unable to keep working, choosing between early benefits or draining your savings while you wait for the higher payout requires some very careful thought.

In general, the lower the returns on your portfolio, the better off you'll be spending down your savings while you wait for benefits to kick in at age 70. If your savings are just keeping pace with inflation, you'll be better off waiting for the age 70 payout, if you live past the age of 83.4 years. If your portfolio is earning a real return of 2.5 percent annually, your "breakeven" age is 87.25 years. In other words, you will be better off with the age 70 benefit if you live longer than 87 years and 3 months — assuming an average bond yield on your nest egg.

If you think living into your 80s or 90s in improbable, you may want to think again. Americans are living longer. The American Society of Actuaries reports that a 65 year-old male has a 50% chance of surviving until age 85. Women fair even better. At age 65, the average woman has a 50% chance of surviving until age 88. Taken as a couple, there is a 50% chance that one spouse will survive to age 92. With the improvements in medical technology, these numbers are likely to climb even higher.

Waiting for the higher payout is like buying longevity insurance. By delaying benefits until age 70, you can better protect yourself from outliving your money. And remember, for each year you delay taking the benefit, your 'insurance policy' will give you an 8 percent benefit increase plus cost of living adjustment. Even an aggressive stock portfolio would struggle to match those returns!

One further reason to wait for the higher payout is to protect your surviving spouse from running out of money. Social Security pays spouses a survivor's benefit ranging from 75% to 100% of the original benefit amount. By taking the later payout at a higher rate, you will ensure a higher survivor's benefit for your spouse and any dependents after your death.

The best way to stay both physically and financially healthy is to keep working at least part time until age 70. By working, you stand to make a paycheck and to grow your social network. Plus, you won't need to dip into your investment portfolio. In the mean time, the interest you earn on your investments between the ages of 65 and 70 will do more to boost your bottom line, more than any Social Security payout strategy ever could.

There are other reasons to be wary of the early payout. Retirees who both work and receive benefits before they reach full retirement age may see their benefits dramatically reduced. Until you reach full retirement age, your benefits will be docked $1 for every $2 you earn above an annual limit. In 2007, the limit is $12,960. But, once you reach full retirement age, you will no longer be penalized for working.

Furthermore, don't be tempted by the myth that you can beat the system by taking the early benefit and investing it. To break even with this strategy, you will need to earn an 8% real return above inflation. If inflation is running at 4 percent, you will need to earn a 12% annual return just to keep up. Trying to earn a 12% return year after year in your own portfolio is a very risky proposition. Chasing after double-digit returns when you could simply delay your guaranteed benefit and watch your future pay increase by 8 percent over inflation is a fool's bet.

There is one main exception to this rule. For some, poor health leaves them with little option but to begin receiving the benefit as early as possible. Seniors struggling with poor health may be wiser to take the earlier benefit, assuming they may not live long enough to make the higher payout worth the wait.

Likewise, if you are much younger than your spouse and your spouse's income was larger than yours, you may want to start taking Social Security early. If they predecease you, your benefit will be increased. For everyone else, the early payout may just be a bad choice.

You should consider carefully when you take Social Security benefits and seek professional advice for your specific retirement path. A fee-only financial planner will sit on your side of the table and help you make the decision that's right for you. To find a fee-only financial planner in your area visit www.napfa.org.

Marotta Asset Management, Inc. of Charlottesville provides fee-only financial planning and asset management. Visit www.emarotta.com for more information. Questions to be answered in the column should be sent to questions@emarotta.com or Marotta Asset Management, Inc., One Village Green Circle, Suite 100, Charlottesville, VA 22903-4619.