Delaying Social Security Benefits Is Often the Best Choice for 60-Somethings
By Jim Krapfel, CFA, CFP
October 1, 2021
One of the biggest financial decisions to make in one’s lifetime is when to claim Social Security benefits. The present value of future payments can easily exceed $1 million for married couples, so it pays to get it right, particularly because the decision is irreversible. However, it appears too many are claiming too early. Indeed, year-in, year-out, over 60% of all eligible workers claimed benefits prior to reaching Social Security’s definition of “full retirement age.” In this financial planning article, I explain why waiting to claim until at least full retirement age is often the best choice for a healthy single person and a higher-earning married person.
Overview of Social Security
The Social Security Act was signed into law by President Roosevelt in 1935. It created a social insurance program designed to pay retired workers a continuing income after retirement. The specifics have changed over the years, but the basic concept -- setting aside a portion of workers’ pay to fund older Americans’ retirement -- has endured. Employers and employees each pay 6.2% of wages up to the earnings taxation limit, set at $142,800 in 2021, while the self-employed pay the full 12.4% up to the earnings taxation limit.
One may begin collecting Social Security benefits any time between ages 62 and 70, provided there are at least 10 years of work. The monthly payment amount depends on three factors – (1) how much income has been subject to the Social Security payroll tax, which determines one’s “primary insurance amount” (PIA); (2) age at first claiming one’s Social Security benefits; and (3) an inflation measure called “cost-of-living adjustment” (COLA). I go through each of these determinates separately.
Figure 6: Three Determinants of Social Security Payment Amount
Social Security Payment Determinant #1: Primary Insurance Amount (PIA)
The PIA represents the monthly payments one can lock in at “full retirement age” (FRA). FRA was considered age 66 or younger for people born in 1954 or earlier, and it increases by 2 months each year until age 67 for people born in 1960 or later. Today, FRA is 66 years, 2 months.
The PIA is based off the “average indexed (inflation-adjusted) monthly earnings” (AIME) over the 35 highest income years, up to each year’s earnings taxation cap. If less than 35 years were worked, then years without work count as 0 and reduce the benefit amount. The calculation of PIA is as follows:
90% for the first $996 of monthly wage income (to $11,952 annualized income) +
32% for the next $5,006 (to $72,024 annualized income) +
15% for the next $5,898 (to $142,800 annualized income)
Figure 7: Annualized PIA Increases at a Decelerating Rate to AIME, to a ~$40k Cap
Source: Social Security Administration. https://www.ssa.gov/oact/cola/piaformula.html
Figure 7 illustrates the means-tested nature of Social Security. The income replacement rate, or the percentage of income during one’s working years that is replaced by Social Security benefits at retirement, quickly declines as average income rises. The effective income replacement rate declines from 90% for someone with $10,000 of average annual income, to 41% for $75,000 income and to 30% for $125,000 income.
Because of the cap on annual earnings subject to the Social Security payroll tax (and figured into the PIA equation), the theoretical maximum PIA one could have in 2021 is $3,383, equivalent to $40,596 for a full year. In reality, it is somewhat lower because the earnings limit on which one pays Social Security taxes each year has risen faster than inflationary benefit increases.
Social Security Payment Determinant #2: Age at First Claim
Again, the PIA amount specifies how much Social Security monthly benefit would be received if claiming at FRA. Naturally, if benefits are first claimed prior to FRA, then the benefit is reduced, and on a permanent basis. Specifically, benefits reduce as follows:
First 36 months prior to FRA: reduction of 5/9 of 1% for each month before FRA; and
Months beyond 36 months prior to FRA: reduction of 5/12 of 1%
More simply, the monthly benefit declines by 6.67% per year for the three nearest years to FRA, and by 5% per year prior to that. For example, if Susan’s FRA is 67 and she started taking benefits four years prior at age 63, then her reduction in benefits would be (3 years X 6.67%) + (1 year X 5%) = 25%.
Conversely, if benefits are first claimed after FRA, then the permanent monthly benefit increases. Here the calculation is a bit simpler, with monthly benefits increased by 8% for each year benefits were first claimed beyond FRA. For example, if Mark’s FRA is 66 years, 6 months and he started taking benefits three and a half years after at age 70, then his monthly benefits would be enhanced by 28% (3.5 years X 8%).
Figure 8 shows how monthly benefits increase when benefits are delayed, in this case for someone with a PIA of $3,000 and an FRA of 67.
Figure 8: Monthly Retirement Benefits for Someone with a PIA of $3,000 and FRA of 67
Source: Social Security Administration. https://www.ssa.gov/OACT/COLA/Benefits.html
Social Security Payment Determinant #3: Cost-of-Living Adjustment (COLA)
The third determinant of monthly benefit amount is an inflation measure Social Security terms “cost-of-living adjustment” (COLA). COLA factors into both the calculation of the highest 35 years of income (indexed to inflation each year, as mentioned earlier), as well as calculating future year benefits. Through this adjustment, benefits typically increase each year to keep up with inflation. The most recent adjustment was 1.3% effective January 2021, but some anticipate a 6% increase in 2022 due to high inflation this year, a nice boost to current retirees’ benefits (though neutral on an inflation-adjusted basis!).
When It Makes Sense to Wait to Claim Social Security
Single People
For single people, determining when to claim Social Security benefits is a relatively straightforward exercise. It comes down to three factors – life expectancy, inflation, and investment returns, when applicable. Social Security breakeven analyses often consider just life expectancy, but the rate at which benefits grow via inflation and how well invested Social Security proceeds perform (or how well an existing portfolio that no longer needs to be sold down, performs) are important factors in economic outcomes.
Put simply, the longer the life expectancy, the higher the expected inflation, and the lower the expected investment returns, the more advantageous it becomes to wait as long as possible before claiming benefits. Conversely, if life expectancy is relatively short, inflation expectations are muted and perceived investment returns are high, then claiming early becomes more attractive.
Delaying benefits will (obviously) have negative economic effects for the first several years because one is not receiving any benefits. The question is at what age must a person reach to be economically better off by delaying their benefits claim and thus receive permanently higher monthly payments? This “breakeven” age depends on inflation and expected investment returns.
Let us look at three inflation and investment return scenarios of a 62-year-old considering whether to take Social Security benefits now or wait until her FRA at age 67. As seen on Figure 9, the low inflation, high return scenario (blue line) carries the longest breakeven period. Meanwhile, the breakeven period is shortened significantly in the depicted high inflation, low return environment (orange line). The breakeven period is curtailed further in the third scenario that entails needing to live off Social Security and not having an investment portfolio that would otherwise have to be sold down to pay for living expenses (gray line).
Figure 9: Cumulative Economic Value of Delayed Claim to Age 67 FRA from 62
Source: Glass Lake Wealth Management analysis
Although one may start claiming Social Security at any point from ages 62 to 70, further reevaluation is warranted upon reaching FRA. Figure 10 uses the same hypothetical inflation and investment return scenarios but this time for a 67-year old at FRA who decides whether to delay all the way to age 70. This delay decision carries longer breakeven points at ages 87, 82, and 79, respectively, versus 85, 78, and 76 in the prior example.
Figure 10: Cumulative Economic Value of Delayed Claim to Age 70 from 67 FRA
Source: Glass Lake Wealth Management analysis
How might the person with average health proceed? A good starting point is to look at average life expectancy. According to Social Security’s period life table for 2019, a 62-year-old man is expected to live to 82, a 62-year old woman to 85, a 67-year-old man to 83, and a 67-year-old woman to 86. These dates augur for waiting to claim until FRA besides those who are particularly bullish on the markets and sanguine on inflation. Waiting to claim to age 70 often makes sense too, but it requires a rosier view of one’s longevity than deciding to wait for FRA.
Married People
For married couples, the calculus changes a bit. A married person can choose to (1) take one’s own benefits, per usual; (2) take a “spousal benefit” while his or her spouse is still alive; or (3) take or a “survivor benefit” when his or her spouse dies. One can switch to whichever provides the greatest benefit, but only one benefit can be taken at a time.
The spousal benefit works by allowing one spouse to take a benefit (who we will call “receiving spouse”) based on their living spouse’s (who we will call “worker spouse”) PIA. The receiving spouse may receive up to 50% of the worker’s PIA benefit provided benefits are first claimed at the receiving spouse’s FRA. Claiming the spousal benefit before FRA carries a high penalty as the benefit amount can reduced by up to 35%. Unlike taking one’s own benefits, there is no enhanced benefit for waiting to claim beyond FRA.
Importantly, a receiving spouse cannot claim spousal benefits until the worker spouse claims his or her own Social Security benefit. The receiving spouse must also be at least 62 years old and the marriage duration must have reached at least one year.
After one spouse dies, the surviving spouse may be entitled to survivor benefits. The surviving spouse needs to be 60 years old to claim benefits with a marriage that lasted at least nine months. If the surviving spouse claims the benefit at FRA or later, he or she is entitled to 100% of the benefit the decedent spouse would have received, but the benefit is reduced by up to 28.5% if the surviving spouse claims early.
Since the survivor benefit is derived from the amount the deceased spouse would have received, the deceased spouse’s timing of taking benefits impacts the amount of benefits for a surviving spouse. There is a greater survivor benefit each year that the deceased spouse delays taking benefits from ages 62 to 70.
Often the most optimal claiming strategy has the higher earning spouse waiting to collect, and the lower earning spouse collecting first. This strategy is especially beneficial if the higher earning spouse has a PIA over double the lower earning spouse. At the time the higher earning spouse claims benefits at FRA or later, the lower earning spouse automatically switches over to the more substantial spousal benefit through a process called “deemed filing.” If the higher earning spouse dies first, the surviving spouse may switch again to the survivor benefit, which pays at least twice as much as the spousal benefit.
If both spouses are highly confident in living beyond their respective breakeven points and benefits are not needed to maintain their lifestyle, then both may choose to delay benefits to age 70. Conversely, it could make sense for both spouses to claim benefits at age 62 if they are both unhealthy.
Bottom Line
For most single people, waiting to claim Social Security benefits until at least full retirement age is the smart move because of the likelihood of living beyond the economic breakeven age and the reduction of longevity risk – the risk of outliving savings. Waiting to claim is typically the best strategy for the higher earning spouse as well due to enhanced spousal and survivor benefits to the other spouse.
There are exceptions to the rule, of course. Claimants who expect to live a shorter than average life or are financially constrained might do better with, or be forced into, a younger claiming age. Further, those who are particularly optimistic about their ability to generate real returns – their investment returns minus inflation – ought to take the money early and invest it.
There is a myriad of other considerations not covered here, such as those that apply to claimants who are still working, have child dependents, are divorcees, or are disabled or have disabled family members. As such, it is best to consult with a Social Security expert before making this important, irreversible decision.
Disclaimer
Advisory services are offered by Glass Lake Wealth Management LLC, a Registered Investment Advisor in the State of Illinois. Glass Lake is an investments-oriented boutique that offers a full spectrum of wealth management advice.
This article is being made available for educational purposes only and should not be used for any other purpose. The information contained herein does not constitute and should not be construed as an offering of advisory, legal, or accounting services or an offer to sell or solicitation to buy any securities or related financial instruments in any jurisdiction. Certain information contained herein is based on or derived from information provided by independent third-party sources. Glass Lake Wealth Management believes that the sources from which such information has been obtained are reliable; however, it cannot guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions in which such information is based.