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Our future, our universe, and other weighty topics


Thursday, June 1, 2017

Future Risks Cloud the Issue of When to Take Social Security Benefits

For Americans approaching retirement age, an important decision is when to apply to the Social Security administration to start getting Social Security retirement benefits. A person can apply as early as age 62, and as late as age 70. The longer you wait, the larger your monthly check will be. For each year that you delay benefits, your monthly check will increase by roughly 7.5 percent. So a person with modest lifetime earnings might choose between getting 1000 dollars a month at age 62, 1335 a month at age 66, or 1783 a month at age 70. If you made more money during your working years, the monthly paycheck at each age might be larger.

Some experts tell us the decision about when to take benefits is simple. They offer the simple formula: delay applying for benefits as long as you don't need the money now. If a person followed this advice, he would ask himself at age 62, “Do I need the Social Security money this year?” If the answer was negative, he would delay applying for benefits until the next year. And he would ask the same question when he was 63, 64, and so forth. He might delay filing for Social Security benefits until he was 70. Or, if he found that he needed the Social Security check at age 67, he might apply for benefits in that year.

But this “delay applying for benefits as long as you don't need the money now” is an oversimplification. The decision on when to apply for Social Security benefits is actually a very complex one. As we will see, all of the following factors are relevant to your decision:

  • Whether or not you need the Social Security check during any year between age 62 and 70.
  • Your current heart rate
  • What age your parents died at
  • Whether you have a family history of cancer or heart disease
  • Whether you are a smoker or obese
  • Whether you are working after the age of 62
  • How much money the US government currently owes
  • Whether you think medical science will invent some anti-aging treatment you can afford
  • How high US budget deficits will be in the coming years
  • How high is the chance that the US government will cancel Social Security or trim its benefits

One tool to help make the decision about when to take Social Security benefits is what is called a break-even analysis. There are online tools that allow you to do this. For example, this site has a tool that asks your full retirement age, your Social Security benefit at age 62, your Social Security benefit at age 66, and your Social Security benefit at age 70. You can get these from your yearly Social Security statement. The site will give you a “break-even analysis” graph like the one below. 

 
What does the graph show you in this case? It shows you that there is a “break-even age” at about age 79. Theoretically, if you expect to live longer than this age, you will get more money from the government by delaying taking your Social Security benefits, rather than taking them at age 62.

So, clearly the simple slogan “delay applying for benefits as long as you don't need the money now” is an oversimplification. A better slogan might be “delay applying for benefits if you think you will live beyond the break-even age” (although I will discuss some reasons why even that slogan is on rather wobbly ground).

How would you tell whether you should expect to live beyond the break-even age? You might go to some actuarial tables, and find the expected life expectancy for a person of your age. The table here (on the Social Security Administration web site) will give you a rough idea.

But there are other things to consider. If you are a smoker or obese, your life expectancy may be shorter than the number listed on the table. If you have a family history of heart disease or cancer, your life expectancy may be shorter than the number listed on the table. If one of your parents died of natural causes before the age of 80, your life expectancy may be shorter than the number listed on the table. If your resting heart rate is above 80 beats per minute, your life expectancy may be shorter than the number listed on a life expectancy table. But if you happen to think that some anti-aging treatment will be invented in the next two decades, and you think that you will be able to afford it, perhaps you will make a higher estimate of your life expectancy.

So matters have got quite complicated. Then there is a whole other can of worms to consider: whether the US government will in the future cancel Social Security or cut back on its benefits.

When giving financial advice on when to take Social Security benefits, almost every book and web site naively assumes that we can be confident that the US government will continue to pay benefits at the current rates, adjusted for inflation. For example, in her book How to Make Your Money Last: The Indispensable Retirement Guide, Jane Bryant Quinn gives us this cheerful assurance on page 72:

But benefits won't drop....Social Security keeps millions of older people out of poverty and saves millions of adult children from having to support mom and dad. No president, no Senate, no Congress will let those voters down.

But there is little basis for being so cheerful. The House of Representatives just passed a bill (approved by the President) that plans to make drastic cuts in health care. President Trump has released a budget that proposes sharp cuts in Social Security disability insurance payments. While the latter is not a cut in Social Security retirement payments, it is so “in the vicinity” that it should raise question marks about whether the government will be trimming Social Security retirement payments in the future. We should also consider that the United States national debt continues to spiral out of control, having reached nearly 20 trillion dollars after 16 years in which it doubled. The deeper the national debt, the more likely that the US government will trim future Social Security retirement benefits.

So whenever you see one of those break-even analysis charts, it might be better to visualize the chart like this. The question marks indicate the uncertainty that future payments will be made far into the future.

There are several ways in which the government could effectively cut Social Security benefits in a roundabout, sneaky way, without directly cutting anyone's paycheck. The government might suddenly raise the retirement age. Someone delaying benefits until he reached 66 might one day find this 66 had become 67 or 68; and someone delaying benefits until he reaches 70 might one day find that this 70 had become 71 or 72.

The government might also modify tax laws so that more of Social Security benefits are taxed. This might be done on either the federal or the state level. Or the government could introduce an assets test for Social Security benefits. So if you had a house worth $200,000 or more, you might find yourself no longer eligible to receive benefits.

Still another underhanded way for the government to shrink benefits would be for the federal government to be miserly in its cost-of-living adjustments, which are supposed to make Social Security payments keep up with inflation. The government already seems to be taking that route. Below are the miserly Social Security cost-of-living adjustments for the past 7 years. 

 
Another sneaky way for the government to reduce benefits would be to privatize Social Security benefits. If your future monthly Social Security checks were replaced by some stock fund that you owned, it would be hard to tell if the second was worth much less than the first.

There is also a very important question we must ask about conventional advice about when to take Social Security benefits. The question is: is such advice based on a faulty investment principle?

When people suggest that you should delay as long as possible before applying for Social Security benefits, they seem to be assuming this type of principle: maximize your chance of getting the most amount of money. Is that a good general principle for people of all ages? It may not be. Consider a person with $20,000 in savings. That person can maximize his chance of making the most amount of money by investing his money in stock options – a risky investment with a potential for very high returns. But stock options are so risky that the standard advice is: never invest in stock options if you need the money you are investing.

Maximize your chance of making the most amount of money” may actually be a poor principle for an older person to follow. And it seems particularly dubious to recommend following this principle to someone so that he can get some extra monetary bonanza that will gradually accrue very late in life – in your eighties or nineties. By then you may be in such poor state of health that you won't be able to enjoy your extra money as much as you would if you were younger. For example, you probably won't be using your extra money to go on some tiring vacation when you are 85 or 90.

A better financial principle may be this: minimize your chance of getting the least amount of money. A person following this principle may come to a completely different decision about when to take Social Security benefits than if he were following the principle of “maximize your chance of getting the most amount of money.”

Let us consider an imaginary scenario of a man named Joe who has just turned 62 and has $150,000 in savings. He retires at age 62, and decides to delay taking his Social Security benefits until age 70, thinking to himself: “I'll get a bigger monthly check if I wait until 70 to file for benefits.” Joe spends his $150,000 covering his expenses over the next eight years. At age 70, he has run out of money; but he applies for Social Security benefits. A few months later, something horrible and unexpected happens: the Social Security program is canceled by a heartless administration. Joe is now left with nothing. He would have avoided this problem entirely if he had taken Social Security at 62. He could have used his Social Security payments to cover his expenses, and still be left with $150,000 at age 70.

If we imagine that Joe has one adult son at age 70, but no wife (who died earlier), and we imagine that Joe dies at age 70, it is a similar situation, except that things are bad for Joe's son rather than him. Instead of getting a $150,000 inheritance, Joe's son is left with nothing.

Joe might have suffered such a disaster if he greedily followed the “young man's principle” of “maximize your chance of getting the most amount of money.” But if Joe had more sensibly followed the principle of “minimize your chance of getting the least amount of money,” he would have avoided this disaster altogether, by taking his Social Security benefits when he was 62.

When some financial adviser advises you to wait to retire until 66, what is he really saying is that it will work out well financially for you if you work until 66 and then start taking Social Security benefits at that time. But such advice is not the same as a recommendation that you should wait to take Social Security benefits until age 66 if you stop working at age 62. If you have more than $80,000 in savings, it can make more sense to start taking Social Security benefits at age 62, because you will get a monthly check earlier and also you might be able to make a lot more in capital appreciation or interest from your savings than you would if you tapped those savings to fund your retirement between the age of 62 and 66. There may also be an additional tax benefit from taking Social Security benefits at age 62 if you have a spouse who is still working. This is because the Social Security benefits are taxed less than 401K withdrawals or non-Roth IRA withdrawals.

I am not a financial adviser, so I cannot make any recommendation on when you should take Social Security benefits. I will merely note that in light of the considerations discussed here, taking Social Security at the earliest possible age (particularly if you are single or if you have decided to stop working at age 62) may be wiser than is generally acknowledged. Be aware that a person advising you to wait until 70 to apply for Social Security benefits may be operating under some principle of “maximize your chance of getting the most amount of money,” which may be a good principle for adventurous young people, but may be an unwise principle for people in retirement or approaching retirement. The quite different principle of “minimize your chance of getting the least amount of money” may lead to a completely different decision on this matter.

Nerdy Postscript: Please ignore this postscript if you never use spreadsheets for personal finance decisions.

There is a way for you to make your own break-even analysis, one that may be more accurate than one done on an online calculator. You can set up a spreadsheet like the one shown below. This allows you to fine-tune the inputs (which in this case are the columns on the left). The simplest way to do the spreadsheet is to just type in the second column the numbers your Social Security statement has given you for how much you will get if you retire at 62, to type in the third column the number your Social Security statement has given you for how much you will get if you retire at 66, and to type in the fourth column the number your Social Security statement has given you for how much you will get if you retire at 70. You can use the Sum() function to create the columns on the right, which provide cumulative totals for the annual benefits listed on the left. 

 
The advantage of creating such a spreadsheet is that you can fine-tune the calculations, making them more realistic for your specific case. For example, in the top left corner you might create a formula which takes into account the fact that if you retire at 62 you may be earning additional income on money you have already saved, interest you would not be earning if you started taking Social Security benefits at age 66.

In your spreadsheet you can then create a graph of the last three columns. The graph will look like one of the break-even charts shown above. But it may give you a more realistic calculation, because you have fine-tuned the inputs.

Below is a spreadsheet graph created from the three columns at right. It graphs cumulative money received under three options: taking Social Security at age 62 (red), taking Social Security at age 66 (yellow), and taking Social Security benefits at age 70 (green), varying over a 28-year time span from age 62 to age 90, with the break-even age occurring at about age 81. This spreadsheet assumes the case of someone not working after age 62. 

 
If you print out such a graph, it would be a good idea to pencil in a bunch of question marks in the upper right corner of the graph. That will remind you that the longer you go into the future, the more doubtful are predictions about money you will receive from Social Security, because of the very substantial chance that benefits will be reduced in the future.