When Should Wealthy Families Elect to take Social Security?
When to begin receiving Social Security remains one of the biggest points of financial confusion for U.S. retirees—even for sophisticated, high net worth families. The confusion is widespread and is largely due to two factors: 1) a desire to take benefits as soon they become available and 2) a lack of clarity over the purpose of Social Security benefits as one part of your broader investment portfolio. The result is that many families are not effectively maximizing the potential benefit that the program provides.
Done correctly, Social Security benefits can provide an excellent baseline for income in retirement, while protecting against longevity risk. The payments are one of the last true pensions available to most citizens: a government-guaranteed income source for life that is adjusted upward with inflation. Unfortunately, many families do not follow the right course when it comes to Social Security planning.
The most common Social Security mistake: people take their benefits far too early. According to the Center for Retirement Research at Boston College, almost half of Americans begin collecting Social Security at the very earliest age possible, 62. Further, about 1/3 of Americans actually wait until full retirement age (66) in order to claim their benefits. And only 9% of Americans wait until after age 66 to claim benefits. The result: Americans are collectively leaving billions of dollars of retirement benefits on the table.
There are several key reasons to delay taking your Social Security benefits. While some are obvious, others are more abstract and involve changing your perspective on what role Social Security should play as part of your overall investment portfolio and savings.
The simple answer to “Why Wait?” when deciding when to take Social Security benefits is that the longer you wait, the higher your payout. For every year of delaying benefits, your annual payout increases by 8%. In other words, if a retiree today were to receive $1,000 per month at the full retirement age of 66, they would receive $1,320 per month by waiting until 70.
When performing a “break even” analysis, you would have to live until your mid-eighties for the higher, later payments at 70 to be worth more than the lower, earlier payments at age 66. Because the actuarial chances that one of two spouses will live until their mid-eighties is quite high, it is almost always the right choice to delay benefits if you can afford to.
When compared to the private annuity market, Social Security begins to look even better. In today’s low interest rate environment, it would cost about $600,000 to buy a joint-life annuity at age 66 that would pay $2,000 per month in benefits. Would the private annuity market offer you an 8% increase for each year you delay? Not even close—delaying benefits in the private market would result in a far lower increase. In other words, the U.S. government is giving you deal that can’t be found in the private sector.
In today’s income starved world, a higher Social Security payment reduces the need to rely on investment portfolios for withdrawals. For example, a family with a $2 million nest egg that required $80,000 per year to live on would be withdrawing at a 4% rate to support their living expenses. Assuming a Social Security payment of $24,000 per year, the withdrawal rate of the investment portfolio suddenly goes to 2.8%. By creating a higher baseline of guaranteed income, we reduce the withdrawal rate of the investment portfolio and improve our long-term outcomes.
For wealthy families, Social Security as a bond substitute is even more compelling. In an environment where high quality municipal bonds yield well below 2%, it would take more than $1 million to create an income stream of about $20,000 per year. By maximizing the Social Security payout we reduce the need to rely on fixed income in this historically low environment.
Social Security as Longevity Insurance
Beyond the simple math that explains that delaying benefits equals more overall dollars, the concept of Social Security as longevity insurance is crucial for wealthy families in planning retirement.
The greatest risk facing retirees today is whether they will ever eventually run out of money. The risk is two-fold: you may live far longer than expected (into your nineties and beyond), or you may encounter a financial crash. While a good financial plan will generally limit the “crash” risk, a 1930’s-type, Great Depression scenario will almost always draw down a retirement account closer to zero than may be comfortable.
The truth is that we don’t know the future and don’t know what’s in store for investment returns. You can do exhaustive analyses that examine withdrawal rate and investment rate of return, but the safest way to ensure ongoing income is to maximize an inflation-adjusted pension that is guaranteed by the U.S. government—your Social Security benefit.
Planning for your spouse is also a key element of the process. While every family is different, the actuarial likelihood is that the wife is going to live longer than the husband. Because of the wife’s ability to keep the deceased husband’s Social Security benefit, a widow is guaranteed a higher monthly income if the husband chooses to delay benefits.
The temptation to take Social Security early is clearly there. After all, you have been paying into the system for 30+ years and it would be nice, for once, to receive something back. But the case for delaying benefits is too great to ignore. By waiting to take payment until after full retirement age, you have increased your expected overall payout, decreased portfolio withdrawal risk and added to the income stream of a surviving spouse. Like many things in life, those who delay gratification will likely be rewarded.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.