The Benefits of Delayed Retirement
Update 12/4/12: Read John Gustavson’s follow-up to this article, which highlights the significant changes in the Social Security program since this article was published — including the deteriorating fiscal situation and generational lows in risk-free interest rates.
For my clients who are near retirement, one of their most common concerns relates to taking Social Security benefits. Unless you are well informed on this issue, a misstep could cost a family thousands of dollars in foregone benefits. So when my clients ask me when they should start taking their benefits, my short answer is, “It depends.”
While it is natural to consult with friends and family who have already made this transition, this important personal decision should be thoroughly researched and explored. If necessary, an experienced advisor can help clarify your particular issues and options.
The first place to start for general information is the Social Security Administration (SSA) Web site. This will provide you with background information on full retirement ages (FRAs), early retirement penalties, and delayed retirement credits (DRCs). It also provides useful online calculators to address various “what if” scenarios.
Social Security benefit basics
Let’s start with the basics. Eligible recipients are entitled to their full Social Security benefit between ages 65 and 67 depending upon date of birth. The Social Security Administration sends an annual benefit estimate to recipients about three months before their birthdays. If you have not received your annual statement, you should contact the Social Security Administration to verify it has your correct information and wage history.
Most people are aware that you can claim your benefit early, usually at age 62. However, by electing your benefit early, benefits are reduced 20–30 percent over the recipient’s lifetime. The decision to take benefits early could also impact the surviving spouse. However, it may make sense to take Social Security benefits early if your health conditions suggest a shorter life expectancy, you don’t have sufficient assets or other income, or you question the solvency of the overall Social Security program. According to the SSA Annual Statistical Supplement, about 73 percent of eligible recipients elect to receive early benefits.
Deferring benefits for singles
More often than not, the best strategy for single recipients is to defer taking benefits until their full retirement age or even better age 69. Of course, this assumes the recipient will live close to the average life expectancy (mid-80s). The Social Security Administration’s online calculator is an excellent resource for this decision. Depending on your assumptions, a person who elects benefits at FRA will receive more total benefits if they live into their early 80s than if they elected benefits early at age 62.
This “break-even age” depends on the person living long enough to collect the full amount of the benefits. The Federal government guarantees your benefits for life. In addition, benefits increase with annual cost of living increases which helps protect against inflation which is Enemy Number One for the retiree.
Benefits for couples
For couples, the decision about when each should take their benefits is more complex. A significant provision passed in 2000 allows spouses to collect benefits when the primary worker is postponing the collection of benefits. If you are at your FRA, you can continue to work and suspend your benefit and earn DRCs. For those who postpone benefits and continue working beyond FRA, the lifetime benefit can increase up to 8 percent of each additional year worked through age 69. This also increases the survivor benefit for the spouse. Lifetime benefits are potentially enhanced for the couple versus the wage earner drawing benefits at FRA.
In their frequently cited research paper “Rethinking Social Security Claiming in a 401(k) World,” James Mahaney and Peter Carlson propose that the optimal strategy to maximize benefits is a 62/70 split. The lower income spouse collects his/her own benefit at age 62 and the higher income spouse delays collection on his/her record until age 70. The higher income spouse waits until FRA and can claim 50 percent of the lower income spouse’s benefits. Retirees who wait until their FRA or later to draw benefits are not subject to earned income restrictions which decrease benefits.
At age 70, the higher income spouse claims his/her own record replacing the lower 50 percent spousal benefit he/she was receiving since FRA. By waiting until age 70, the higher income spouse will receive DRCs and cost-of-living-adjustments on his/her benefits. In addition, assuming the higher earning spouse dies first, the lower earning spouse steps into a much larger survivor benefit.
On second thought …
After some research, if you regretted your decision to take benefits at age 62, all is not lost. Social Security will allow a “re-do.” By filing Form SSA-521, Request of Withdrawal of Application, and repaying all previous benefits, you can re-file and collect the higher benefit. You don’t have to pay any interest and are allowed a tax deduction or tax credit for the income taxes paid on the benefits previously collected (see IRS Publication 915). Of course, you will need to have the dollars available to repay all of the previous benefits, and your longevity and break-even analysis should be considered as well.
Each person needs to evaluate these options based on their own needs and circumstances including health and life expectancy. A face-to-face meeting with a Social Security Administration representative along with your CPA and financial adviser is also wise. There just isn’t a single solution that fits everyone when it comes to drawing Social Security. However, by choosing wisely, you can live out a long retirement and draw larger benefits that are indexed for inflation.