When Will You Start Collecting Social Security Benefits: The Math?

The Math Behind When to Start Collecting Social Security Benefits

As I shared in the last edition of RETIREMENT GAME PLAN, a new Relaxing Retirement member had a host of questions surrounding social security this past month so I thought it would be a good idea to share my thoughts with you as these are questions I receive all the time.  (To protect their privacy, I’ll refer to them as Bill and Madeline)

Since they were both age 62, one of their first questions was, “should we start collecting social security now, or wait until Full Retirement Age, i.e. age 67?”

As I explained to Bill and Madeline, there are 2 major factors to consider before collecting social security benefits before your “full retirement age.”  In the last edition, we began with “the penalty” if you begin too early.  Today, let’s explore the second major factor: The Math.

#2: The “Math” Behind the Decision

The second factor to consider is the math.  Since Bill is the one considering working part-time after he retires from his full-time work, he’s the one we are going to focus on today.  Madeline’s decision is actually different and we’re going to expand on her options in a little while. 

Bill’s social security benefits statement shows that his monthly benefit at age 67 will be $3,000 per month.  And, if he begins collecting at age 62, his benefit will be $2,100 per month.

If Bill starts collecting now, he’s going to take a 30% pay cut!  That doesn’t sound too great, does it?

However, he really needs to take a look at the math for a moment:

  • Monthly Benefit at age 67 (if he waits)         $3,000
  • Monthly Benefit at age 62 (today)               $2,100

If he takes his benefit today, Bill is going to receive $900 less per month.

What This Math Really Means for You

As I pointed out to Bill and Madeline, if they decide to wait until Bill reaches age 67, what they’re really saying is that it’s worth it to wait 5 years (or 60 months) to get the extra $900 in the 61st month and beyond.

However, another intelligent question to ask is “what are they giving up by waiting”? 

What they’re giving up is 60 months (5 years from age 62 to age 67) of social security benefits.  That’s $126,000!

Not an insignificant number.

The “Break Even” Age

In order to recoup that $126,000 that they would give up by waiting until age 67, Bill would have to live another 140 months after age 67, or 11.67 years, at which time he’d be 78.67 or 79 years old.  ($126,000 divided by the incremental increase of $900 at age 67 = 140 months)

So, in order to break even, Bill and Madeline would have to live another 16+ years (4 years from age 62 to 67 + 12 years = Age 79).

And this doesn’t take into consideration 3 other factors:

  1. Bill and Madeline are eligible to receive a cost of living increase each year on their social security benefits, so their benefits will begin increasing after their first year of collecting. 
  2. If Bill and Madeline begin collecting at age 62, they could invest their monthly check and potentially earn even more.
  3. Finally, and this is the most important factor in maintaining their lifestyle sustaining income over the rest of their lives, if they don’t draw from social security right now, they must draw income from some other source, i.e. their Retirement Bucket™ of investments. 

    Delaying social security reduces their inflation fighting investments more rapidly because they have to make up for the income social security would have provided, thus reducing the amount their heirs will receive at their death because social security benefits end at your death.

    And if the majority of their investments are in IRAs or other retirement plans, it may potentially reduce them even faster because they have to pay income taxes on 100% of what they withdraw vs. a maximum of 85% of their social security income.

Other Factors for Bill and Madeline to Consider

While Bill and Madeline’s example should give you a good guideline to use, here are some other factors which may affect your own unique situation:

  1. Life Expectancy:  Bill and Madeline are both in good health and have no overriding problems.

    The reason why this is a factor in their decision is that if they have health issues that are predicted to shorten their life expectancy, clearly this should lead them to collect benefits as early as they can get them. 

    As it was in Bill and Madeline’s case, however, if everyone in your family has lived well into their 90s, this may pull you in the opposite direction.
  2. Severance: If you’re collecting severance pay from the employer you’re retiring from, this may alter your desire to begin collecting right now because of the taxes you’ll pay on your social security benefits while you’re also receiving large severance pay.
  3. Deferred Compensation: This same principle applies to deferred compensation.  Let’s say that for the 5 years prior to your retirement transition, you’ve contributed to an executive deferred compensation plan.  If the plan calls for you to receive a payout immediately upon retiring, as many of our members do, this may have adverse tax consequences on your social security benefits.
  4. “Other” Income: If you have other “locked in place” income, you have to weigh the after-tax benefits of collecting social security benefits early. 

    This dovetails into a major principle that I recommend, and that is to never make any decisions concerning benefits or investments without also simultaneously considering the tax consequences. 

    This is a monumental mistake that I see in way too many situations. 

As you can see, there are several factors that went into Bill and Madeline’s decision.  Hopefully, their example provided a good line of questions for you to answer in your own unique set of circumstances.

In the next edition, I’m going to delve into the questions Madeline had about collecting her social security benefits.

Surprising to many, benefits collected by working and non-working spouses vary greatly if you don’t know the rules.

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