If you have looked into the issue of when to claim Social Security (SS) benefits for more than 30 seconds you have seen 100 eggheads screaming “Don’t touch it before the age of 70!!” Well, here we go again – – with an important twist.
One fundamental premise of this blog is that we are targeting the Do-It-Yourself investor. As a result, we anticipate the fact that “this is what we found” is not going to cut it. In other words, that is not going to be convincing by itself. So, let’s do the following. Our file page includes a small spreadsheet model that you can use to address the issue. We are not here to tell you the “answer”. Instead, we are interested in explaining how to find it yourself for one simple reason. If you don’t find it yourself – you should NEVER believe it.
The model in place is really small, and really simple. Consider Alternative A – in which you claim Social Security ASAP. For the vast majority of readers in the US this is at age 62. We are going to scale the numbers so that this first check is set to $1000. Yes, we know that the average check is closer to $1700 so just think of this as 100% of that value. We assume that this value grows at 3%/12 = 0.25% each month. This figure is a bit less than the average inflation rate in the US since 1929, which is closer to about 3.3%. For SS payments, we note that this value only adjusts once per year, but this approximation feels close enough. We also assume that upon receipt, these funds are invested and earn 0.5% per month, which is roughly 6% per year. The long-term average return on an S&P 500 Index fund is significantly greater than this, but we suspect that in retirement, you will be much more likely to buy stupid things like bonds, no matter what we say and get a lower return on average.
At the end of month t, the value of this stream is labeled Vt. This amount is the value from the previous month, plus the size of the incoming check, adjusted for the 0.5% investment return over the period. This looks like:
Vt = (Vt-1 + Pi) * (1.005)
Here, Pi is simply the SS payment for that month. Remember, Pi is adjusted each month for inflation, so this grows over time. We can track Vt over time. It grows due to the monthly, inflation adjusted payments, and the accumulated returns. The resulting list of values includes V12 = $12,567, V60 = $75,267, V100 = $145,943. We can take this even further and see V120 = $188,957, V200 = $427,657, V240 = $598,759, and V300 = $944,680. Note the accelerating growth in value due to the compounding of payments with inflation, and asset appreciation due to investment. Moving from year 1 to year 10 (V12 vs V120 ) this value rises by $188,957-$12,567 = $176,390. The next 10 years sees growth from $188,957 to $598,759 which is an increase of $409,802. Compounding really is like magic.
In Alternative B you get nothing for months 1 – 100. At month 101 you get the updated SS check amount. To estimate this payment, we start with the base value of $1000, and adjust it for 100 months of inflation, and for 100 months of “Growth”. The SS system essentially rewards you for delaying the start of payments by increasing the check size by about 8% per year, which looks to us like 8/12 = 0.66% per month. This growth is not quite the same as an investment return – but is can be accounted for in much the same way. Thus, the first check in month 101 becomes $1000 * (1.0025)^100 * (1.0066)^100 = $2,494. From this point forward, we assume the payments grow with inflation, and are invested to earn the same investment return rates across both alternatives.
Under these assumptions, Alternative A produces a whopping $145,943 in month 100 vs. nothing in Alternative B. In fact, Alternative A is the clear winner for the next 140 months or so. Under Alternative B we see V12 = $0, V60 = $0, V100 = $0. Looking ahead from that point we see V120 = $56,747, V200 = $369,114, V240 = $600,001, and V300 = $1,076,314.
You may want to study those two sets of numbers. Clearly, Alternative B does not look better until about month 240. In fact, the second set overtakes the first set exactly at month 240. This probably makes it feel like Alternative A is the clear winner – but hold on. 240 months is exactly 20 years. Thus, taking the money early works out better as long the payments end before the age of 82. If you live longer than that, Alternative B is better, and the gap grows as additional months are added on.
Now, I understand that many of us do not plan on living that long. However, we have to also consider the spousal benefit (after my wife outlives me.) While I plan to be long gone before month 240, she plans to stick around a bit longer, if for no other reason than to finally have a clean house without some nerd-slob constantly messing things up.
This result is fully consistent with a host of models discussed elsewhere and reaches roughly the same conclusion. Delay payments until age 70 (at least) if it is reasonable to believe that you will live beyond age 82. However, it feels safe to say that our model is both a bit simpler, and very easy for you to play around with.
If you are like me, you already noted one HUGE caveat. A 6% return is a pretty far cry below the long-term returns on a diversified portfolio of equities. That value is closer to 7% ABOVE INFLATION. If you assume a 7% nominal return Alternative A is better up until about month 260. At 8%, its better up until about month 285.
Assuming higher returns does lend added support to the idea that Alternative A is likely to work out better for many people. But consider this. If you do live to age 82, the remaining life expectancy at that point is another 7 to 8 years (roughly 90 months). In addition, we have ignored the natural variability in these returns, which further increases the appeal of Alternative B because the Growth that we spoke of earlier is guaranteed by law. (At least for now.)
Run the numbers yourself. We suspect that you will see a very strong case for the old boring rule of thumb – take the payments at age 70 and let the rest take care of itself.
