When planning for retirement income, a common practice and a common assumption sometimes collide to reduce long-term financial security, not enhance it.
The great majority of people claim Social Security benefits before their full retirement age as defined by the Social Security Administration. In 2012, 79 percent of men and 80 percent of women started receiving permanently reduced benefits rather than wait for higher payments.
About half of the early claimers start when first eligible at age 62 even though their benefit is 25 percent less than if they waited to full retirement age (staggered through age 66 if you were born between 1943 and 1959, 67 if you were born in 1960 or after).
Of course, many people claiming early do not have financial options to do otherwise.
Among those who have saved a retirement nest egg and chosen to retire, some pair early Social Security with the assumption that they should postpone use of employer retirement plans or IRAs for as long as possible to extend the benefit of investing with pre-tax dollars.
However, for some people, the opposite course – using IRA/401k withdrawals as a source of income while postponing the start of Social Security — can actually improve the longevity of the investment account and its tax efficiency while paving a path for substantially more guaranteed Social Security income.
For each year that you postpone the start of Social Security income after initial eligibility at 62, you receive an 8 percent increase in your payment. In investment markets, there is certainly no guaranteed way to increase income or returns by 8 percent, especially for a conservative investor.
The decision isn’t quite so simple, however. There are many factors that influence the most optimal choice. Life expectancy, the size of your Social Security benefit in relation to your expected expenses, your spouse’s Social Security income, age and health, your expected investment return, how much of your nest egg is in after-tax Roth accounts vs. pre-tax accounts, and more personally specific issues.
OPTIMIZE RETIREMENT INCOME
If you are retired at 62 but wait four years to 66 to claim Social Security, you may have to live on a bit less for the four-year period, but this action can buy a higher standard of living through the longer remainder of retirement.
Using invested assets to methodically fill the income gap will likely cause the balance of savings to decline more sharply than you envisioned in the first handful of years while you postpone Social Security. But once the larger Social Security payments kick in, IRA/401k withdrawals can theoretically level off. In many scenarios, the longevity of the investment portfolio can be improved vs. starting smaller Social Security payments earlier and supplementing them with larger pre-tax investment withdrawals throughout retirement.
Which path is right for you should be determined through purposeful planning. How do you know which route is better for your personal situation without modeling the “what if?” choices to see how they affect the probability of funding your goals?
For some people, optimizing income solely for their own lifespan is the goal. For others with bequest motives — or a younger spouse — the claiming strategy might be different.
By modeling scenarios that fit your situation, you can make an informed decision in advance instead of choosing the default option of the unprepared.
THE FEAR OF WAITING
Most people claim early, because they fear if they die early, they will not receive back what they paid through decades of payroll taxes. It’s another example of our instant gratification society that generally disregards long-term thinking.
Waiting for larger payments later in life means you have to live to a certain point to exceed what you could have received in small payments over a longer period of time. Generally, this is around age 81.
Actuarially, if you live to average age, starting smaller payments early should be close to neutral to larger payments later. Those in poor health may lean one way, but a healthy person in his 60s has a significant possibility of living past the break-even period.
Along with potentially dying early, many people are concerned about the future of Social Security. While Social Security income could be challenged by an aging population, it is not an all-or-nothing scenario.
Even without any adjustments to the way Social Security is funded, there will be enough workers to provide recipients with about 77 percent of current benefit estimates. Likely, there will be adjustments which could maintain expected Social Security income, especially for those who most need it.
Ideally, smart planning and use of your financial resources should help make the future of Social Security income less important to your ultimate financial security.Gary Brooks is a certified financial planner and the president of Brooks, Hughes & Jones, a registered investment adviser in Old Town Tacoma. Reach him at email@example.com.