Most personal finance experts suggest that you wait to claim Social Security benefits as long as possible because every year you delay (until you turn 70), the higher your monthly benefit will be. But some investors may see an opportunity in taking Social Security early: Doing so would allow them to spend less on their own assets, leaving more money tied up in savings where it can continue to grow.
Sure, it’s possible to get ahead by claiming Social Security early when you factor in the returns on your investment. But for most retirees, it’s probably not worth the risk.
Image source: Getty Images.
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 eligible to do so, they reduced your monthly benefit by 30% to $1,138.
Instead of using that income to pay bills or go on vacation, he invests it in a special account. Each month, you buy $1,138 worth of stocks, bonds, and whatever other assets you think will provide the best return over the next five to eight years. Ideally, this will result in a bonus portfolio that you can draw on for the rest of your retirement that will more than make up for the larger payments you missed by not waiting to receive Social Security.
Assuming an average annual cost of living adjustment of 2%, you could have claimed a benefit of $1,794 per month if you had waited until age 67 to do so. That compares to the $1,256 per month you’ll actually be collecting by then, since your monthly payment of $1,138 will also have earned those 2% COLAs over time. Based on a safe withdrawal rate of 5.3% over 20 years, the portfolio created with those first Social Security checks would need to have grown in value to $121,866 to fund the $538 monthly difference. To achieve that, a consistent return of just under 20.7% would be needed.
Waiting to claim benefits until he was 70 would have resulted in Social Security checks of $1,028 more per month. To safely provide that much cash flow, the portfolio he funded with those Social Security checks would have had to have grown to $232,784 over the intervening eight years. That would require a constant annual return of almost 16.2%.
Typical expected returns don’t come close to building a portfolio large enough to safely replace delayed Social Security. Graphic source: Author.
Those are rare results. Only about one in ten eight-year rolling historical periods has produced average annualized returns greater than 16.2%.
A case study
However, I can’t imagine anyone investing their Social Security income in a separate account. Instead, they are more likely to use program income to offset how much they have to withdraw from their existing retirement portfolio.
Imagine you retire at age 62 with a retirement portfolio of $1 million. You can cash your $1,625 Social Security check at full retirement age in five years, or you can start receiving your benefit right away and collect $1,138 per month. You have budgeted $53,650 per year for expenses and taxes. (Conveniently, that’s 4% of $1 million, plus your 12 monthly Social Security checks.)
Again, we’ll assume a 2% cost of living adjustment, which is the inflation metric used to increase your annual withdrawals as well. Each year, you withdraw enough from your retirement portfolio to make up the difference between your budget and your Social Security income. So if you delayed Social Security, you would have to withdraw the entire $53,650 from your wallet in that first year, but you could reduce it to just $40,000 if you claimed earlier.
At age 92, 30 years after retirement, for you to have the same portfolio value as if you had delayed applying until age 70, your retirement portfolio would need to have produced constant annual returns of 7.78%.
That might sound achievable. But most retirees’ portfolios are designed to preserve capital and therefore have more conservative asset allocations, leading to less robust returns. Also, a poor sequence of annual returns early in retirement will hurt the early claimant more, requiring a higher average return to get ahead.
The table below shows the value of the portfolio at age 92 based on various portfolio returns. It also shows how a poor sequence of returns to start retirement can affect ending portfolio values.
| claim at 62 | claim at 67 | claim at 70 | |
|---|---|---|---|
| 5% constant return | $771,409 | $904,391 | $968,079 |
| 7% constant return | $2,754,432 | $2,819,502 | $2,832,901 |
| 7.78% constant return | $3,973,320 | $3,990,975 | $3,973,321 |
| 7.78% bad sequence* | $4,122,064 | $4,483,862 | $4,418,309 |
| 7% poor sequence** | $809,616 | $1,088,240 | $1,165,032 |
*A sequence in which the portfolio returns 2% over 10 years, 10.4% over the next 10 years, and 18.8% over the next 10 years, for a compound average growth rate of 7.78%.
**A sequence where the portfolio returns 2% over 10 years, 7.08% over the next 10 years, and 12.16% over the next 10 years, for a compound average growth rate of 7%.
Table source: author. Author’s calculations.
In fact, delaying the day you file for Social Security provides good protection against a weak period for your investments early in your retirement despite higher portfolio withdrawals. That’s because there’s a planned decline in withdrawals five to eight years after retirement.
Other Real Life Considerations
The above examples 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 positions before that new stream of income enters the equation. Retirees need to consider things like required minimum distributions and capital gains, and a few years without any additional income can provide opportunities to scale back later.
The other consideration is that retirees should err on the side of conservative. What’s more important to you: maximizing your net worth at age 92, or making sure you don’t run out of money before then? Social Security offers a great return with very little risk for those waiting to collect it. While it’s possible (albeit unlikely, in my opinion) that you could get through it 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 benefit.
If you want to claim Social Security early just to invest it, you better be very confident that you’ll 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 during those early years, you’re probably better off doing so and then reducing your annual withdrawals after claiming Social Security at age 70.
