The Social Security Age Dilemma

EDITOR'S NOTE: This article was originally published in the December 2007 issue of Kiplinger's Retirement Report. To subscribe, click here.

To claim or not to claim Social Security -- that's the question facing nearly 80 million baby-boomers as the first wave of them turn 62 next year. To underscore the demographic milestone, the Social Security Administration staged a media event recently to witness the nation's oldest baby-boomer, Kathleen Casey-Kirschling, as she applied for her retirement benefits online three months before her 62nd birthday on January 1.

But just because boomers can claim benefits early doesn't mean they should. In the past, the majority of retirees chose to start collecting benefits when they were eligible at 62, even though it meant accepting reduced benefits for the rest of their lives.

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If you were born between 1943 through 1954, you can collect full benefits at 66. Start collecting at 62 and your monthly checks will be permanently reduced by 25%. For each year you delay beyond 66, you'll receive an extra 8% until you reach age 70.

"There's a tendency to grab the bird in hand and collect benefits as soon as you can," says Conrad Ciccotello, a professor of financial planning at Georgia State University. "But longer life expectancies make that decision to take benefits early less appropriate."

Unfortunately, there's no consensus on the magic age. Over an average lifetime, the total value of the higher benefits taken later equals the total value of the smaller benefits taken earlier. Once you live beyond your "break-even" age (which you can calculate at www.ssa.gov), you would have been better off waiting to collect full benefits.

For many people, the choice of when to start Social Security benefits is clear-cut. If you need the income to make ends meet, take your benefits early.

Sometimes it's obvious that you should wait. If you plan to continue working and expect a substantial income, you should delay collecting benefits. Otherwise, you will lose $1 in benefits for each $2 you earn over the earnings limit of $13,560 in 2008 if you are younger than 66.

Say that you qualify for early benefits of $18,000 a year and your part-time job pays you $50,000 -- $36,440 above the earnings cap. If you claim early, you'll forfeit all of your benefits because your earnings above the cap are more than double your benefits.

"If you have high earnings, there is no discussion -- you're not going to take benefits," says Steven Feiertag, a certified financial planner in Royal Palm Beach, Fla. You can also use the earnings-test calculator on the Social Security Web site.

There is some good news: A more generous earnings cap applies the year that you reach your normal retirement age. Once you hit your birthday, the earnings limit will disappear. And when you reach full retirement age, your benefits will be increased to take into account those months in which benefits were withheld.

Remember, you can start taking benefits at any time between age 62 and 70. Up to age 66, the reduction will be smaller if you wait longer. For instance, if you take your benefits at age 63, your benefits will be reduced by 20%.

How Long Will You Live?

For most other situations, the right age to start benefits may be less obvious. You'll need to consider other sources of income, your investment style and the impact of benefits on a surviving spouse.

A major factor to consider is your likely life expectancy. Determining your break-even age can be helpful. The earlier your break-even point, the more it makes sense to wait -- especially if you expect to live much beyond that age.

For example, a 62-year-old who takes a reduced benefit of $1,425 a month would receive the same total benefits by age 77 and 11 months (based on 2007 dollars) if he or she takes the full retirement benefit of $1,900 at 66. If the beneficiary lives beyond that break-even age, waiting to collect would be the better option.

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If you're in poor health, the decision is easier. In 1998, William Vose, a retired real estate developer, underwent heart-bypass surgery. Four years later, he calculated his break-even point and decided to collect at 62. "I didn't think I was going to live a long life," says Vose, now 67, who lives near Richmond. "If I do, I'm not going to complain."

But for others, there's a lot more guesswork involved. The median life expectancy for a 62-year-old man is 81, and a 62-year-old woman is likely to live to 84. But that means half of today's 62-year-olds will live even longer. "Most people think they won't make it, but people can easily live to 80," says Dallas Salisbury, chief executive officer of the Employee Benefit Research Institute.

Still, taking benefits early could make sense if you invest the money, or rely on your benefits for cash flow and allow your savings to remain invested. Even if Vose's life expectancy were not an issue, he says he probably would have taken benefits early anyway. "I'm an active trader, and I thought I could do better with the money than the government could," he says.

Indeed, Social Security's break-even calculations do not account for investment earnings. If you can successfully invest your early benefits, you can delay the break-even age by a few years.

The key is your rate of return. The higher it is, says Ciccotello, the more it makes sense to take benefits early. Optimally, your investments would need to earn at least 4% a year after inflation. That would suggest a portfolio heavily weighted toward stocks. In the event of an early death, the money will be part of your estate and available for your heirs.

But Ciccotello warns that if you end up pulling out money for an emergency, this strategy won't work. And Henry Hebeler, author of J.K. Lasser's Your Winning Retirement Plan (John Wiley & Sons, $21), questions whether retirees, who tend to reduce their investment risk by scaling back on stocks and adding more bonds, can count on maintaining consistently high returns. He offers a free program at his Web site (www.analyzenow.com) to help you decide when to take Social Security benefits.

Hebeler's program also factors in the impact of taxes on your benefits. A portion of your benefits is taxed if your combined income -- the sum of your adjusted gross income, plus nontaxable interest and half of your Social Security benefits -- exceeds certain limits. You may want to delay taking benefits if earned or investment income will cause a larger portion of your Social Security benefits to be taxed.

For married couples, up to half of their benefits are taxable if their combined income is between $32,000 and $44,000 (if you're single, the range is $25,000 to $34,000). Up to 85% of benefits are taxable if the couple's income exceeds $44,000 ($34,000 for singles). Because the limits are not indexed for inflation, more of your benefits are likely to be taxed each year.

The Marriage Equation

Single men and women, particularly those with little savings, should consider working as long as possible to maximize their benefits. A larger benefit will pay off year after year as your annual cost-of-living adjustment will be applied to your higher base benefit. Plus, a few extra years of work could marginally increase your benefits and give you more time to boost retirement savings.

Married couples face the most challenging timing decision, especially if they have widely disparate incomes. Even if you think you can get good investment returns, taking your benefits early can backfire on your spouse.

If, say, the wife earned less than her husband, she's entitled to claim a benefit based on her own earnings or she can collect a "spousal benefit" that's worth 50% of her husband's. A wife can collect her own benefit at 62, but she cannot collect a spousal benefit until her husband files for his benefit.

If he dies first, she's entitled to a survivor benefit equal to 100% of her husband's benefit. Considering a woman's longer life expectancy, for couples who are concerned about maximizing survivor benefits, a husband should delay taking benefits as long as possible. If he waits until age 70 to collect and dies first, his wife will be entitled to 132% of his benefit if he had taken it at full retirement age.

However, Christine Fahlund, senior financial planner for T. Rowe Price, says that some married women may be willing to forgo higher survivor benefits. Instead, their husbands could collect early and invest the money in a separate account that their wives could tap in their later years. This strategy could be appropriate for couples with a high net worth who can rely on a pension or other assets until the husband reaches 70, Fahlund says.

Let's say the husband takes $18,750 in pretax Social Security benefits starting at age 62. For eight years, he invests the after-tax benefits in an investment account with an after-tax return of 6.36%. At age 70, he starts spending his new benefits but leaves the investment account alone. By age 85, the separate account would have grown to $437,000.

As for giving up higher survivor benefits, Fahlund says: "It's all about trade-offs. Some women would want higher income later, and others would want a bigger nest egg. They like knowing it's there and they can touch it."