Tuesday, October 26, 2010

At What Age Should You Collect Social Security?

Many folks think that " waiting"  until you are 70 to collect social security is a good idea, as you "get more"  per month. But on the other hand, if you collect earlier, you may get more overall, in some cases.  Once again, like with insurance and annuities, you have to think about how long you are going to live and then take a gamble on that.

At what age should you collect Social Security?  Living on Retirement Island, this is a hot topic of conversation, and everyone has their own theory.  Many seniors opt to wait as long as possible - until age 70 if then can, on the grounds that they will collect more per month, which obviously is better, right?  But unfortunately, that type of thinking illustrates the cash-flow or monthly payment mentality that Americans are taught to think, which often results in poor financial planning.

A younger friend of mine who was an accountant, did the math on this and decided to collect earlier.  One reason he decided to collect earlier is that while waiting for his "normal" retirement age to come up, he was chagrined to see it raised by 8 months.  As he put it, what is the point in "waiting" for "full retirement" if they keep raising the bar while you are waiting?  In theory, you could end up waiting forever.

In a way, it is like the frustration a 17-year-old faced in the early 1980's when they raised the drinking age.  One day you are just weeks away from being "legal" and the next day, bam! - they've pushed it off for another three years.  A bum deal!

If you are like most Americans, you've gotten these Social Security projections from the government on a regular basis. They are, in effect, a sweet lie, as most of us plan our retirement based on these projections, while at the same time, government officials tell us not to count on getting that money.  Yet another bum deal for our generation.  We got a lot of those, it seems.

Anyway, using my 2009 report as an example, it claims that at age 62, I can collect $1463 a month if I take "early" retirement, or $2085 a month if I take "full" retirement at age 67,  or if I wait until age 70, I can get $2586 a month.  Which is the best deal?

Well, let's first assume that I live according to the actuarial tables and kick the bucket at about age 76, which is typical for most men.  If that were so, the total collected for each option would be as follows:
  • Age 62 - Age 76: (168 months) @ 1463/mo = $245,784
  • Age 67 - Age 76: (108 months) @ 2085/mo = $225,180
  • Age 70 - Age 76: (72 months) @ 2586/mo = $186,192
Wow.  If you die at age 76, which is the average, you come out ahead, in terms of overall amount paid, if you take social security early.

But suppose you lived to be 80?  Actuarial tables are an interesting thing, as they list the average age for people to live.  However, if you are already 50, then you have been "culled" from the group of people who died early, due to accident or early illness.  And thus, you might be expected to live longer than age 76.  If you die at age 80, the numbers change as follows:
  • Age 62 - Age 80: (216 months) @ 1463/mo = $316,008
  • Age 67 - Age 80: (156 months) @ 2085/mo = $325,260
  • Age 70 - Age 80: (120 months) @ 2586/mo = $310,320
Wow.  Also interesting.  If you die at age 80, taking the money at age 67 ends up being the better deal, in the abstract.  But note that the "spread" between all three options is not very high - a few thousand dollars, really.  It really is a wash.

But wait, suppose you don't "need" the money yet, as some Seniors claim, and thus want to wait?  Suppose instead, you take the $1463 a month and invest it at 2% interest for five years?  That five years of money, banked at a modest rate, would be worth $92,809, or about  $5029 more than the $87,780 paid out in the interim. In other words, if you invested the difference, you might end up breaking even, or perhaps coming out ahead, particularly if you are willing to take risks for higher rates of return.

Now suppose you live to be 85, which is pretty damn old. Yea, I know, you secretly think you are the Methuselah and are going to live forever, but the reality is, you are highly likely to take a dirt nap long before age 90.  And if you live beyond that, you won't know if it's snowing or blowing, in most cases. So who cares?
  • Age 62 - Age 85: (276 months) @ 1463/mo = $403,788
  • Age 67 - Age 85: (216 months) @ 2085/mo = $450,360
  • Age 70 - Age 85: (180 months) @ 2586/mo = $465,480
Now you can see you start to pull ahead if you outlive the average.  At age 90, you'd really be ahead.  But let's face it, the expenses of living at age 90 will swallow up all of your income, assets, and Social Security, as you will likely be in a retirement home by then.

The Social Security Life Expectancy Calculator provides a sobering view of life.  For example, according to their calculator, I will live to be 81.3 years old, on average.  Wow, Heinlein's Dr. Pinero could not do much better!  This is a sobering little experiment:

The following table lists the average number of additional years a male born on March 22, 1960, can expect to live when he reaches a specific age.

At Age Additional Life Expectancy
(in years)
Estimated Total Years
50 and 7 monthsa 30.7 81.3
62 21.5 83.5
67b 17.7 84.7
70 15.6 85.6
a Your current age.
b Your normal (or full) retirement age.

Note: The estimates of additional life expectancy:
  • do not take into account a wide number of factors such as current health, lifestyle, and family history that could increase or decrease life expectancy.
  • are based on
    • the gender and date of birth you entered (your cohort) and
    • information from our cohort life expectancy tables.
      (Some of the information can be found in the 2010 Trustees Report.)
Note that the longer you live, the longer you can expect to live - that is the rub.  In other words, each year you live, your lesser-lived brethren are culled from the mix, and on average, the remainder will live longer.  In Electrical Engineering, we call this "burn-in" - culling the "infant mortality" from the production line.  In Retirement Analysis, I guess we could call this "burn-out".

But again, if you don't really "need" the money until age 70, the benefit of taking the "early" money and investing it may outweigh the benefit of taking the money later.  Assuming you take that $92,809 you made by investing your early withdrawal, at age 80, at 2% it would be worth about $120,000.  It still does not "level" the playing field, but makes the options a lot closer to one another.

All of this is an interesting academic discussion, and of course, you have to "crank your numbers" accordingly and see what works for you.  And for many people, the issue is just academic.  They lurch into retirement at age 62 and desperately need that $1463 a month to live on.  There is no discussion there - they cannot wait until age 67 or 70 to collect, unless they starved.

And for many others, the monthly cash-flow is king, and they can "survive" on $2586 a month, but not on $1463 - the idea of banking and saving the difference is not even an issue.  So they'd rather wait until age 67 or 70 to collect, and keep working, if possible, than take a smaller amount now, and bank it.

And of course, taxes play a role here, too, as  Social Security benefits are now taxable to some extent, so you should factor that into play.  If you are working at age 62, that extra $17,556 a year could push you into a higher bracket, meaning you will pay more in taxes, and thus collect less, overall.

Others have looked at the numbers and come to the same conclusion as I have - that overall, you get more money if you take it early.  The Social Security website also has a number of calculators to help you calculate your relative benefits.

The truth is, everyone's situation is different.   If you have a series of serious health issues and both of your parents (and your grandparents) died young, then taking the benefits at age 62 is probably a safe bet.  And if you need the money, it isn't an issue up for discussion, is it?

The only scenario I can see where you might "regret" taking early benefits, is if you are one of those "monthly cashflow" people who lives paycheck-to-paycheck and looks at Social Security as the last in a series of paychecks.  If you have no savings and no other sources of income, then taking early retirement (if you can still work) may end up being a bad idea if you need money later on - and you don't have the WILLPOWER to "bank" those "early" Social Security checks between age 62 and when you need them.

In other words, even thinking about when to take it is a game that only the fairly well-off can decide to play.  Most folks don't have a choice in the matter, as they live paycheck-to-paycheck and either desperately need the money at age 62, because they are laid off, or need the extra money at age 70, because they have no savings and will "work until I'm 70" - or so they think.  Usually, those are the people who end up taking the money at age 62, not by careful design, but out of desperation.

For me, this is a decision I don't have to make for 12 years.  But thinking about retirement NOW will help you have a better one later on.  And at age 50, 12 years will go by in a flash.