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BOSTON
— Many Americans take
Social Security
early, at age 62, because they really need it. They're
in poor health or unemployed or both. Others take
benefits early because they're worried they'll lose out
on what's rightfully theirs if benefits are reduced. But
few people try to figure out the best age to take
Social Security
— and that's a serious mistake.
Even
though it's challenging, calculating the best time to
take benefits is well worth it, especially given that
Social Security
represents about one-third of the average retiree's
income.
What's
key is evaluating the so-called break-even period to
determine whether it would be better to delay
Social Security
benefits (delaying them means a higher monthly benefit),
take a reduced benefit early, or start them at
"normal" retirement age. Of course, there's a
good reason why so few people really do the
calculations.
"When
to begin
Social Security
retirement benefits is a challenging question that vexes
many financial planners and clients,"
Michael Kitces
, editor of The Kitces Report, wrote in a recent issue.
Living
beyond the break-even point can produce large amounts of
wealth relative to the risk. But delaying
Social Security
benefits does represent a serious risk, Kitces said: If
you wait and then die before claiming your benefit, it
really messes things up for your widow. Still, there are
situations in which delaying
Social Security
retirement benefits can pay off significantly.
"Is
it better to begin payments early, or to delay
Social Security
and forfeit current payments to receive a larger income
stream in the future?" he said. "Although the
analysis of such a question would seem relatively
straightforward, the complex rules of
Social Security
make the evaluation more difficult, especially when
evaluating the implications of living beyond the
so-called 'break-even' point."
PUTTING
IT OFF CAN PAY OFF
One of
the biggest risks to your retirement plan is unexpected
longevity — living longer than you expect and having
to fund additional years of retirement. "The
decision to delay
Social Security
provides tremendous additional value, at the exact time
that it is needed," Kitces said.
Another
risk: High inflation. "To the extent that inflation
turns out to be unexpectedly high, delaying
Social Security
benefits also turns out to be an effective inflation
hedge, because the value of delaying increases in higher
inflation environments," he wrote. Though not the
case now, during high inflation, which many predict on
the horizon, you would get larger cost-of-living
adjustments.
Also, a
low rate of return on investments poses a risk.
"The decision to delay (benefits) also turns out to
be an indirect hedge to poor returns in the
portfolio," Kitces wrote.
HOW TO
DECIDE
"At
the most basic level, the decision about whether or not
to delay
Social Security
retirement benefits represents a very straight-forward
trade-off," Kitces wrote. "You can either
receive cash payments now, in your pocket, to spend or
invest however you choose, or you can give up those
payments in exchange for receiving a higher stream of
income for life at a future date."
Here are
the things you should consider to make a more informed
decision.
1. What's
your normal retirement age?
The first
order of business: You need to know what your normal
retirement age, or NRA, is. If you were born in 1937 or
earlier, it's 65. If you were born in 1960 or later,
it's 67. And if you were born between 1938 and 1959,
it's somewhere in between.
Of note:
If you were born in 1943, your NRA is 66. And since it's
now 2009, that means anyone born in 1943 is now at NRA,
the age at which you can receive your full
Social Security
benefit. You can find your NRA at this Social Security
Web site: http://www.ssa.gov/OACT/ProgData/nra.html
Once you
know your NRA, you can calculate how much
Social Security
benefits will be increased or decreased if you choose to
take your benefit later or earlier than your NRA. Take
your benefit before NRA, and it's reduced by 5/9ths of 1
percent for each month the benefits begin early, up to a
maximum of 36 months before your NRA. Take your benefit
after your NRA and the benefit is adjusted upward,
depending on the year in which you were born, due to the
"delayed retirement credit." With delayed
retirement credits, at least under current law, a person
can receive his or her largest benefit by retiring at
age 70. A person born in January of 1943, for instance,
who waited until 50 months after reaching full
retirement age would have a benefit of about 132 percent
of their primary insurance amount. You can get a sense
of how much larger your benefit would be at this Social
Security Web site: http://www.ssa.gov/OACT/quickcalc/early—late.html
2. Will
you be working?
Next, you
need to determine whether you'll be working, especially
if you have not yet reached full or normal retirement
age, according to Kitces. Because of
Social Security's
earnings test, Kitces says it's almost always a bad idea
to take
Social Security
benefits early if you have earned income greater than
the earnings test threshold.
Social Security
withholds benefits if your earnings exceed a certain
level, called a "retirement earnings test exempt
amount," and if you are under your NRA.
But it's
also important to note that one of two different exempt
amounts applies, depending on the year in which you
reach your NRA. Under the earnings test, your
Social Security
benefits are reduced by
$1
for every
$2
of earned income that you have in excess of
$14,160
per year. But if your NRA is 2009, your benefit is
reduced
$1
for every
$3
of earned income in excess of
$37,680
.
3. How's
your health?
At the
end of the day, Kitces said the most significant factor
in the entire process of evaluating the decision to
delay
Social Security
is whether you're likely to live long enough to receive
value from higher monthly benefits. The shorter your
life expectancy, be it because of health, genetic, or
other relevant factors, the less prospective value to
delaying
Social Security
. If you're not expected to live long enough to reach
the break-even point or you're so unhealthy that you may
only live a few more years, "it will virtually
always make sense to begin benefits as soon as possible,
and get as many payments as possible," Kitces said.
Now the
tricky part here is two-fold: First, what's your life
expectancy? In 2006, life expectancy at birth for the
total population reached 78.1 years, according to the
Centers for Disease Control and Prevention
. But a managed 62 has a life expectancy of about 19
years, and a woman of the same age has a life expectancy
of 22 years.
By the
way, you can calculate your personal life expectancy at
Living to 100.com.
Besides
calculating your life expectancy, you need to calculate
your personal break-even number. According to Kitces,
once you factor in such things as the time value of
money with an appropriate discount rate and the
inflation adjustments for the increased benefits when
delaying
Social Security
benefits, break-even points vary from 15 years to 23
years. So don't blindly accept some rule of thumb that
you've read — crunch the numbers. One such calculator
can be found at analyzenow.com with others on the Social
Security Web site, www.ssa.gov.
THE
TRADEOFFS
Now, if
you don't plan to automatically defer benefits or start
benefits early, Kitces said, "you have to evaluate
the prospective tradeoffs between electing benefits
early, or delaying benefits with the risk of not living
to the break-even period and the opportunity for wealth
creation by living beyond it."
To do
this, you first have to pick a conservative growth rate,
as well as an assumption for inflation. What's more, you
need look at your retirement cash-flow needs and other
income sources and investments, the risks you might face
in retirement, and your longevity. Once you have a sense
of the tradeoffs, you can come up with the best possible
answer for your situation, rather than the rule-of-thumb
case.
THE
CAVEATS
If you're
married, you'll need to figure out what impact your
decision regarding the timing of your
Social Security
benefits will have on both spousal benefits and widow's
benefits. Also, you'll need to figure the effect of
taxes on your decision.
"
Social Security
benefits have their own unique rules for determining the
amount of benefits that will be subject to taxation, and
there is significant interplay between the taxation of
Social Security
benefits and other aspects of the client's planning
situation that may create taxable income and affect the
taxability of
Social Security
," Kitces said.
There you
have it. You can certainly take
Social Security
early if you want. Goodness knows many do. But given
that
Social Security
might represent one of your largest assets and perhaps
your most dependable income stream, wouldn't you rather
know that you had it as close to right as possible?
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