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The Math of Social Security

In today’s low yield world, you’ll earn little interest by keeping your money in a bank account, a money market fund, or a high quality bond. Nevertheless, certain individuals can earn 8% a year, guaranteed by the federal government. If you are between age 62 and age 70, deferring the start of Social Security retirement benefits provides that return, which, for many people in that age group, makes waiting a savvy move.


Basic math

You can start to receive Social Security benefits as early as age 62. Before your full retirement age (FRA), though, you’ll receive reduced benefits for the rest of your life. Say your full retirement age is 66, as it is for people born from 1943 to 1954 (age 59 to 70 this year). By starting your Social Security benefits at 62, you’ll receive only 75% of your FRA benefit.

Example 1: Mark Jones has a work history that entitles him to $2,000 a month from Social Security at 66, his FRA. Instead, Mark starts his benefits at age 62. Mark will get $1,500 a month (75% of $2,000) for the rest of his life, plus any cost of living adjustments (COLAs).

Example 2: If Mark decides to wait until age 66, his FRA, he will get his basic $2,000 a month for the rest of his life, plus COLAs. Thus, by waiting 4 years, Mark increases his monthly benefit by $500—a 33.3% increase from $1,500 a month in example 1—which is about 8% a year for the 4 years he waited.


Patience is prudent

Beyond your FRA, deferring the start of Social Security will increase your benefits by 8% a year (actually, by ⅔ of 1% for each month beyond your FRA). This goes on until age 70; deferring benefits beyond 70 provides no additional cash flow.

Example 3: Mark Jones waits until age 70 to begin his Social Security benefits. This 4-year delay beyond his FRA increases Mark’s check by 32%, from $2,000 to $2,640 a month, plus all the COLAs that took effect while he waited. Altogether, waiting to start benefits increased Mark’s monthly income from $1,500 at age 62 to $2,640 at age 70: a 76% increase in 8 years. That’s a 76% return, guaranteed by the federal  government.


Later than sooner

Waiting for Social Security has an obvious cost. If Mark Jones had started at age 62, with a reduced $1,500 monthly benefit, he would have collected $18,000 that year; by age 70, he would have collected $144,000 in benefits, plus COLAs. If Mark had started at age 66, receiving $2,000 a month, he would have received $96,000 plus COLAs in the 4 years before age 70. When does it pay to take the money as soon as possible? When does it make sense to wait? Here are some guidelines:

Do you need the money? If Social Security benefits are necessary to maintain your lifestyle in retirement, you probably should take them.

How is your health? The shorter your life expectancy, the more likely you and your loved ones will be well served by taking the benefits while you can. Assume, though, that Mark Jones is in good health with no pressing need for extra cash flow from Social Security. If he takes his benefits before age 70, he will pay tax and spend, save, or give away the aftertax amount. If he decides to reinvest, he’ll either have to settle for a low yield or take investment risk in the hope of receiving a superior return. For Mark, waiting in this example provides certain benefits. He’ll earn an annual return of around 8%, plus COLAs, on his full (untaxed) Social Security benefit. The return from waiting will be longevity insurance: a reduced risk of running short of money if Mark lives into his 80s and beyond. In addition, assume that Mark Jones is married and that his wife had lower lifetime earnings than Mark. In this case, Mark is entitled to a larger Social Security benefit than his wife. If Mark dies first, his widow will be entitled to his full Social Security benefit for the rest of her life, rather than her smaller benefit. Therefore, an older and higher earning spouse who waits to receive Social Security is essentially obtaining more life insurance for a surviving spouse.

Copyright AICPA

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