Deciding when to claim social security benefits is an essential part of retirement planning. There is not a one-sized fits all answer to this question. This article will weigh the factors to consider and offer examples of when one strategy may make more sense than another.
Before jumping into the pros and cons of Social Security claiming strategies, I want to address a common misconception I hear from people when we are designing a personalized plan for their retirement. “The fund is going to run out, and I will lose my benefit if I do not start taking Social Security now.”
If there are no changes to the current laws, the existing trust fund will run out in 2035. The current social security trust fund contributions (workforce paying into the program) can cover 80% of the social security payments. Additionally, Social Security benefits are a mandatory expense of the Federal Government. If the fund runs out, the government would need to close the gap.
If we look at the historical perspective of Social Security, in the 1980s, we faced a similar problem. The fund was going to become insolvent in August of 1983. Reagan created the “Greenspan Commission” in 1981. The commission reported their findings in January of 1983, which led to Congress adjusting the law and preventing insolvency on April 20th, 1983, a mere three months before the fund ran out. Rewriting the laws around social security is a complex and challenging hurdle, one that politicians will likely procrastinate on for years.
Politicians will continue discussing it, slowly moving it closer to the legislative queue’s front. President Biden released a detailed plan on the campaign trail, which includes a new tax tier and would extend solvency and set up a more extensive reform in the future. With all that is going on globally, it would be hard to see something like this take priority. But history and recent political rhetoric suggest something will adjust to ensure the program remains functioning as it was intended well into the future.
Full Retirement Age & Benefits
Full Retirement Age (FRA) determines when a retiree can receive full benefits. FRA was recently changed from age 65 to a range between 66-67 depending on birth date. Retirees age 62 and older can claim benefits, but claiming before FRA will result in a permanent 30% reduction of monthly benefits.
For retirees willing and able to delay claiming Social Security beyond FRA, they receive an 8% increase each year up to a max of 24% increase in their benefit.
Each year Social Security benefits increase based on your annual Cost-of-living adjustment (COLA). COLA is calculated on your benefit base, which means individuals who claim early will set their benefit base lower and see lower COLA adjustments over time. Simultaneously, claimants who wait longer will start at a higher benefit base and therefore receive higher COLA adjustments.
Why retirees should claim Social Security Later
Blaise Pascal was a seventeenth-century philosopher famous for “Pascal’s Wager.” The “Wager” posed the argument that it is best, for self-serving reasons, to believe in God. If God does not exist, then a misplaced belief will have relatively small consequences. However, if God exists, then the faith’s impact becomes the key to eternity in heaven for believers and eternity in hell for non-believers.
Pascal’s wager can also apply to Social Security and longevity risk. Similar to the existence of God, most people won’t know the length of their retirement until the end. We can think of four general outcomes:
- Claim early and experience a short retirement.
- Claim early and experience a long retirement.
- Claim late and experience a short retirement.
- Claim late and experience a long retirement.
While experiencing a short retirement is undoubtedly unfortunate, claiming earlier would result in the maximum lifetime benefits claiming late would have resulted in minimal harm. The retiree would have received less in benefit payments, and there would have been less time to spend down assets or put pressure on the portfolio, likely leaving plenty of assets left to heirs.
Alternatively, for people who experience a long retirement, the consequences become more severe. People who claim early set up conditions for a permanently reduced standard of living in retirement. By delaying claiming Social Security, retirees set up conditions for a permanently enhanced standard of living.
Why It May Make Sense To Claim Social Security Early
Legitimate arguments exist for claiming Social Security early. Sometimes individuals need the funds to survive and do not have viable income alternatives to help them delay.
People may want to claim early because of medical conditions that lead people to believe they will not live to age 80 or beyond. In this case, it is also essential to consider survivor and dependent benefits.
A household with two spouses may make sense to claim the spouse with lower lifetime earnings first and delay the spouse with higher lifetime earnings. There are also circumstances that the higher earner may want to claim earlier to take advantage of benefits for dependent children or dependent parents.
In 1972 a group of psychologists at Stamford University did a study known as the “The Stanford marshmallow experiment.” In the study, a child was offered a single marshmallow, and the adult researcher offered a second marshmallow if they waited a short time before eating the first one.
Social Security is the marshmallow test for adults. It is more likely better to delay claiming Social Security until age 70. But for some people, they may want to claim early.
With so many options and so much money at stake, it is important to test individual situations using comprehensive Social Security planning software that includes all relevant variables.