One of the recommendations I get the most pushback on from retiring clients is to defer their Social Security benefits until age 70.
Note: It’s not appropriate to defer for EVERY client in every situation but certainly for most folks near retirement age for whom I work it appears to be the best decision.
Before I go any further, let me very briefly explain a few of the primary options: The “Full Retirement Age” (FRA) at which people will qualify for their full benefit is around age 66-67 (depending on year of birth). However, you can begin taking a reduced benefit at age 62. Alternatively, you may elect to defer Social Security until age 70 and receive a greater monthly benefit for your lifetime and that of a lower-earning spouse’s lifetime.
For example, if you were born in 1960 or later, your FRA is age 67. By taking benefits early at 62 you would get a 30% reduced benefit. However, for example, if you were born in 1943 or later, your monthly benefit increases 8% each year you defer beyond FRA up to age 70 (or 2/3rds of 1% each month deferred).
There are several reasons that deferring to age 70 is in most people’s best interest:
- It likely results in higher lifetime benefit.
- It provides a hedge against outliving your assets. Many retirees have the financial risk of outliving their financial resources…a higher monthly social security benefit until the end of life and spouse’s life is a hedge against that risk. Social Security is an inflation-adjusting lifetime annuity.
- It can provide a phenomenal risk-free return unmatched by the market (if you live long enough) even after accounting for lost benefit in the initial few years.
- Deferring gives us a few more years of low/no-income and, therefore, a low tax bracket in early years of retirement to perform some tax arbitrage (accelerating IRA distributions / Roth IRA conversions, etc…).
- Ultimately, it results in a higher probability of success of the family achieving their financial objectives. In other words, it typically results in a lower chance a downward adjustment to spending at some point in retirement will be needed.
The risks / downside to deferring are:
- Dying prematurely / before the “breakeven point” is achieved (more on that).
- A greater portion of spending must be funded from another source (typically investment portfolio) for those few years of deferring.
So, typically, we find it makes sense to defer for folks who are relatively healthy. Obviously, if someone is quite sick with a short life expectancy or there are serious family health history issues we need to be concerned about then that might be cause to take Social Security earlier.
Additionally, another reason to defer that is particularly unique to today’s market environment, specifically, is that stocks are so extremely overvalued. Therefore, it’s actually an opportune time to defer social security, get the guaranteed benefit increase and fund living expenses from the portfolio as you’re effectively “selling high.” There’s no better time to sell assets to fund expenses than when prices are at extreme highs and assets are more overvalued than they’ve ever been in history.
Conversely, I have clients who are deferring, but we’re operating with the understanding that if/when there is a severe bear market and asset valuations become more reasonable/cheap before they turn age 70 we will reevaluate this decision. In that scenario, we may elect to file for benefits before age 70. The reason is that when assets are more reasonably valued/cheap their projected forward returns are greater as opposed to today when valuations are extreme and projected returns are very low (today, risk assets contain a ton of embedded risk with very low potential returns). In that scenario we may want to preserve our attractive investments and utilize Social Security to supplement.
The reason I’m writing this commentary now is that I am about to present a plan to a client who is retiring later this year, and this is one of the major financial decisions we must make together. They’d really like to take social security immediately. However, my job is to help them make the most informed decision that is in their best interest consistent with their long-term financial goals.
Their financial projections include two scenarios: (A) Take Social Security at Full Retirement Age, and (B) Defer Social Security Until Age 70. The first thing we notice is that the result of Scenario A is an 87% “probability of success” (i.e. 13% chance a spending adjustment will be required) while the result of Scenario B is 97%. Deferring represents a SIGNIFICANT improvement over taking Social Security at the client’s FRA.
Furthermore, we notice in the graphic above that there is no “Safety Margin” in Scenario A in the case of a Bad Timing Scenario (a stress test that simulates a bad bear market in the first two years of retirement).. This “Bad Timing” stress tests a client’s financial independence against “Sequence of Returns Risk,” which is a critical concept I’ve discussed previously.
If we model a modest 11% portfolio decline starting immediately we would likely need to reduce retirement spending for at least a time while Scenario B affords us the ability to maintain desired spending.
Assuming Husband lives to age 88 and Spouse lives to age 92 and a 1.8% Cost Of Living Adjustment (COLA), the total lifetime benefit of taking SS at FRA for this particular client is $1,149,443 while the lifetime benefit is $1,374,493 when deferring to age 70. The crossover / breakeven point where deferring to age 70 provides a greater cumulative benefit is at age 78 (2033).
Of course, we must account for time of value money. Turns out when using reasonable historical rates of return, we find that the breakeven point is around 85-87. However, given extremely high valuations today it is not reasonable to use historical average returns as actual returns will likely be less than historical averages in which case the breakeven point is between 78-85. Of course, none of this accounts for the dollar savings arising from the tax planning mentioned earlier in point #4).
This is not a specific recommendation for anyone reading this commentary because an appropriate, prudent, informed recommendation can only be made after preparing financial projections that account for your unique circumstances. Let me know if you or anyone you know would benefit from this process.