“When should I take Social Security?” is the first question everyone faces when contemplating retirement. More than 50% of all men and women start taking benefits at 62. By age 66, well over 90% of all men and women are taking benefits according to the Center for Retirement Research at Boston College.
The popular financial press typically asks readers to consider the “break even” age — that age when the total benefits of taking Social Security early outpaces the credits we receive by delaying. This approach is similar to the way one considers buying down a home loan with “points” and asking ourselves: “How long do I expect to live in this home?”
Enrolling for benefits early means a lower Social Security payment; collecting at age 70 provides a payment that is 8% a year higher for each year delayed after the full retirement age. In other words, as the popular recommendation goes, one should calculate how long one needs to live in order to “break even,” that is, live long enough to collect enough from the SSA that the total amount collected is at least equal to the amount you forgo in electing to take reduced benefits. If you die before that date, the SSA wins; if you die after that date, you win.
The “option set” this presents to people assumes a kind of “gamble” situation (“break even”) rather than an economic situation or even a life-cycle planning situation.
If what’s at stake here is bragging rights on a bet, this “break even” methodology might be a reasonable method to consider. But what’s at stake is lifetime living standard and the insurance against longevity that Social Security provides. The risk of one’s house burning down has a particular actuarial possibility. The risk of a serious health problem likewise might be presented as a percentage as in a “1-in-a-1000” possibility. But few of us would be willing to drop our insurance because of the probability that we won’t need it. The reason is because we are risk averse: we care much more about protecting ourselves from bad things than we do about the possibility of positive outcomes.
The fact that on average, a 50-year old male will die at 78 may be a fact, but the possibility of that same male living to age 100 is a reasonable possibility. We protect ourselves from what might possibly happen, not from what, on average, will probably happen. And living until age 95 or 100 is a real possibility for most people — especially for those that reach age 65 at which point the average age of life rises to 83 for men and 85 for women. But again, it’s possibilities, not averages that we must plan for.
I’d like to contribute to our recent discussion (referring to Should You Delay Your Social Security Benefits article) by presenting a different view — a case that argues that delaying Social Security until age 70 is nearly everyone’s best option. The exception is those with a terminal illness or those with no other source of income.
Let’s consider Jack and Jill Delay. They are both 60 years old and their children have left the nest. They each make $125K a year, and their employer matches their 5% contribution to the 401(k). This $6,250 (plus employer match) will continue until they quit working at the end of their 64th year of age. They just refinanced their home, and they have 12 years left to pay and a $100K loan balance. So their monthly payment is $925 and their annual taxes are $3K and their homeowner’s insurance is $1K. They each have accumulated $350K in their 401(k) and, as a couple, they have $200K of regular assets in a mutual fund. Let’s assume all of their assets — retirement and regular — earn a nominal rate of 6%, i.e., just 3% over the assumed 3% rate of inflation.
And to make things more complicated, I’ve intentionally included a ten-year gap in Jill’s earnings history (let’s pretend she took a hiatus to raise children or study jazz piano). This means that she has less benefit than her husband. To be precise, she will receive $21,944 at age 65 and Jack will receive an annual benefit of $22,088. If they delay until age 70, they will receive $31,035 and $31,238 respectively. But that’s not all. Because Jack will apply for benefits and then immediately suspend, Jill will receive a spousal benefit of $11,833 beginning at age 66, her age of full eligibility and this will continue through age 69 when her $31,035 benefit kicks in. Jack is not penalized for this strategic maneuver.
Before answering that question, let me call attention to some of the language I’ve used in the introduction above. As a professor of writing and rhetoric, I study language use in what we call discourse communities. I want us to think about this financial situation, not as a gamble with talk about “breaking even” but rather as an economic situation, as a life-cycle decision, as an economic puzzle where there is an optimal solution measured by the highest and smoothest lifetime living standard. However it’s not just a preference for one kind of language over another that I’m expressing. My argument hinges on the fact that we measure the advantage of one financial choice over another by comparing the lifetime living standard that is the result, not by the isolated outcome on just one particular piece of the puzzle.
So, for example, when Jack and Jill retire at 65 and take Social Security, they will see their total tax burden (FICA, Federal, and New York State) drop from $94,398 to $17,863 (81% drop) in the first year (see sidebar). If they delay Social Security to age 70, this tax burden drops 92 percent in the first year. But this fact alone is just one piece of the entire economic puzzle, and it should not itself be the reason that they should delay.
In the same manner, a break even point should not itself be the reason for delay or not delay. The reason to delay or not to delay has to be evaluated by the bottom line of highest lifetime living standard. My argument is that anything other than this bottom line is short-sighted economics.
By living standard, I mean the discretionary spending this couple has to live on after they have paid their taxes (FICA, Federal, and State), housing (mortgage payment, taxes, and insurance), Medicare Part B premiums (beginning at age 65 and rising each year at the recent historical rate of 4.5%), and contributions to retirement (which end after their 64th year of age). What’s left over is what is meant in this case by living standard.
Taxes, housing, and Medicare premiums are not static amounts. Indeed, they are mutually related and interact with each other and inflation in complex ways. For example, Social Security can be subject to taxes, which would impact lifetime living standard. When taxes are low — as in the 5-year period when Social Security is being delayed — this provides more resources to live on. And housing — the mortgage payment piece of the puzzle — is paid off in today’s dollars because of the fixed mortgage rate so that the cost of housing effectively declines each year until payoff. Taxes related to mortgage interest are thus affected as well.
If Jack and Jill take their Social Security at age 65, they will experience an annual lifetime living standard of $82,353. If they delay Social Security until age 70, they will experience an annual lifetime living standard of $88,196. That’s a 7% improvement — $5,843 more in today’s dollars each and every year of their life beginning at their current age of 60!
I’ve used ESPlanner software (www.esplanner.com) to calculate these results. This analysis is not black-box smoke and mirrors or an estimate. This analysis is based on current Federal and New York tax tables and accurate Social Security projections based on the particular earnings history I used for this couple. Anyone using the program could replicate these numbers and the results are all presented in tabular spreadsheet format so they can be examined. Anyone doing the math without the aid of this program — which of course would be very difficult to do — would get the same results.
So now for the results, which will be presented in today’s dollars so that inflation is accounted for and numbers can be easily understood.
Let’s look at a few of the tables from the ESPlanner report. This table shows the annual taxes dropping at age 65 and then going up again when Social Security clicks in at age 70.
|Age||Total Income||Total Spending||Taxes||Saving||Regular Assets|
This next chart shows the declining housing expenses due to the effect of inflation, and it also shows the cost of Medicare Part B. Notice that after the home is paid for at age 72, what remains is taxes and insurance that rises with inflation (i.e., is steady in the table below because we are looking at today’s dollars, or dollars adjusted for inflation).
Note also the Living Standard column. This is our “bottom line” and ESPlanner is solving the problem so that although housing costs are declining because of inflation and Medicare B premiums are rising, and inflation marches on — yet, the living standard (presented in today’s dollars) is steady at $88,196. When comparing options in this program (e.g., when to take Social Security, whether to use a Roth IRA or a traditional IRA, what might be the impact of moving to a different state, refinancing a home, etc.), it’s the resultant sustainable, lifetime living standard that provides the bottom line answer for the purpose of comparing options.
|Age||Living Standard||Housing Expenditures||Jack’s Retirement Account Contributions||Jill’s Retirement Account Contributions||Medicare Part B Premiums||Total Spending|
Finally, we can look at the total income of this household. Again, income is not our final target in retirement planning despite the planning industry’s focus on “replacement income” and “income needed in retirement.” Our bottom line is living standard. Thus, if our household income can drop from $262,331 at age 64 to $57,525 at age 65 and then back up again to $112,578 at age 70, so what! The bottom line is not income, it’s available discretionary spending — or living standard. In this case, the living standard remains steady or smooth at $88,196 from age 60 through age 100, which is 7% higher each year than it would be if they took Social Security at age 65.
|Age||Jack’s Non-Asset Income||Jill’s Non-Asset Income||Jack’s Retirement Account Withdrawals & Annuities||Jill Retirement Account Withdrawals & Annuities||Regular Asset Income||Total Income|
The approach presented in the pages above (with the help of ESPlanner) is called the economic approach to planning because it does not treat each related problems piecemeal but rather as a systematic whole puzzle with mutually related parts. Taxes, asset interest income, inflation, Social Security, 401(k) withdrawals, spousal benefits, Medicare Part B premiums, and a fixed mortgage rate are some of the interrelated factors considered in this case. In a different case we might also factor in long-term care, a reverse mortgage, annuitizing assets, etc. Every case is different. But the main point here is that we cannot just look at a single factor like “break even point” to determine if we should delay Social Security. This decision is part of a complex economic puzzle, and the bottom line is not income, taxes, break even point, or housing cost, but rather annual living standard from the current age forward.
Planning to take Social Security at age 70 instead of age 65 allows Jack and Jill to experience a higher living standard from the date they make that plan forward. If Jack and Jill, currently 60 years old, both tragically die at age 68 — before they’ve taken even one dollar of their Social Security — they will still have lived 8 years at a 7% higher living standard than they would have lived had they planned and then taken their Social Security at age 65. Granted, the SSA might boast that they won the actuarial wager, but Jack and Jill won’t be around to hear it.