Deciding when to begin receiving Social Security benefits can be confusing.
The choice involves making certain assumptions, including approximately how long you will live, as well as projecting cash flows from all sources in retirement. Delaying the start of benefits results in larger payments, but risks leaving money on the table in the event of premature death. How to decide?
The amount you receive once you begin Social Security depends on your earnings history and when you decide to file. The Social Security Administration uses the 35 highest-earning years adjusted for inflation to calculate a baseline monthly benefit available to claim, called the primary insurance amount. This monthly benefit is the adjusted up or down based on early or delayed commencement of benefit payments.
Social Security was created in 1935 to provide supplemental retirement income payments beginning at age 65. In 1956, women were afforded a reduced benefit beginning at age 62, a provision extended to all participants in 1960. These options for early payments resulted in the concept of the full retirement age, sometimes referred to as the normal retirement age. The full retirement age is the year in which a worker can claim their full benefit (the primary insurance amount).
The full retirement age has gradually risen from 65 to age 67 since 2000. For example, individuals born in 1959 have a full retirement age of 66 years and 10 months, while the age for those born in 1960 or later is 67.
Legislation passed in 1972 offered workers a modest increase in annual payments for delaying retirement beyond age 65. Major changes in 1983 enacted to address a looming solvency crisis sweetened the delayed credit, so today a beneficiary earns an 8% raise for every year they delay past full retirement age up to age 70.
Electing to begin Social Security before reaching full retirement age should be evaluated carefully, since it results in significantly lower benefits for life. For instance, someone born in 1960 who began at 62 receives just 70% of their primary benefit. This reduction is permanent and does not increase at full retirement age, other than across-the-board cost of living increases. Note that it is possible to reverse course by repaying any benefits received but only within 12 months after filing.
According to the Social Security Administration, over half of all workers file for benefits before reaching full retirement age and over one quarter file as soon as they are eligible.
On the other hand, delaying past full retirement age increases the monthly benefit by 2/3 of 1% per month or 8% per year up until age 70. Waiting an additional three years results in a 24% permanent raise over the primary insurance amount, a handsome return.
The benefit formula was theoretically designed to be actuarially neutral: on average, it should not matter when one began receiving payments. If a worker survived to their statistical life expectancy, the smaller checks over a longer period from age 62 resulted in approximately the same total payout as fewer, larger checks commencing later.
However, because the actuarial assumptions are 40 years old, the program is no longer actuarially neutral but provides a lopsided reward for delaying. In the aggregate, most people would optimize their lifetime benefits filing at 70. According to the Centers for Disease Control and Prevention, life expectancy for a 65-year-old is now around 82 for men and 85 for women.
Of course, other considerations like health conditions, cash flow constraints and genetic factors regarding longevity play a role in the decision process.
The decision to delay benefits is also not entirely irrevocable. In fact, the program offers you something of a Mulligan available after reaching the full retirement age: a partial retroactive payment.
For taxpayers who reach full retirement age and opt to delay filing, the rules allow for a lump sum distribution of up to six months back pay should you change your mind. You forgo the incremental increases to your base benefit for those months, but if it turns out that delaying creates too much of a financial hardship or circumstances change, the fallback option may be attractive.
Consider a worker born in 1960 who is entitled to $2,000 per month if she files at her full retirement age in March 2027. Knowing her benefit will increase by 8% if she waits for another year, she opts to delay filing. However, by September, she begins to regret her decision and decides to begin benefits. That half year delay would result in a 4% larger monthly benefit or $2,080 per month going forward, but she can also choose to drop back to the primary amount and receive a lump sum payment of $480. Therefore, the decision to delay filing is essentially a series of six separate, revocable six-month options until age 70.
In our example above, waiting until 70 would pay off over time if the retiree lives beyond age 79 1/2, a prospect that is increasingly likely. There are several helpful tools on the Social Security website ssa.gov to help you evaluate your own options, or consult your financial advisor for advice and assistance.
Every situation is unique, and you should begin by creating your own Social Security Administration account if you have not yet done so. In general, delay is profitable, but understanding the options and their consequences is critical to making the most informed decision for your own personal circumstances.
Christopher A. Hopkins, CFA, is a co-founder of Apogee Wealth Partners in Chattanooga.
Christopher Hopkins