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Let’s finally put that debate to rest (and find the best time for you to start taking it)

“I can take Social Security when I’m 62, invest the money, and earn more than if I waited for the larger payouts!”

— Commonly voiced claim

This is a very exciting idea. Social Security pays you less at age 62 than at age 67, but if you don’t urgently need the money, you’ll have five years of income to invest and grow before you get so much as a penny of the larger sums you’d get at your full retirement age.

It’s even more exciting if you were planning to take benefits at age 70 because you’ll have an eight-year advantage.

With that big of a head start, will the higher amounts you get at age 67 or 70 ever catch up?

Let’s find out.

How Social Security works, and the argument for taking it early

You and your employer have been paying Social Security taxes throughout your entire career. Your taxes and the taxes of millions of other workers are immediately distributed to current retirees (with excess amounts going into a trust fund). The amount retirees receive depends on two factors:

1. How much they earned in the top 35 years of their careers, and
2. When they elected to begin receiving benefits.

For example, if you had a career with an income that scaled up over time to a peak of $80,000, and you were 62 today, you’d get something close to the following (calculations from SSA.gov using ‘future’ dollars’):

• $1,400 a month if you started taking at 62
• $2,400 a month if you started at 67 (they call that your “full retirement age,” or “FRA”)
• $3,400 a month if you waited until age 70

The Social Security Administration doesn’t care when you take your money. Some people die young and some live longer but on average retirees die in their early ‘80s and if they do the total amount received is the same — smaller amounts for more years or larger amounts for fewer years.

Can we game the system?

The argument for taking benefits early claims that the SSA uses very conservative calculations in their growth estimates and that an average investor can achieve much better growth in the market. So if one were to take benefits early and invest them, they’d come out ahead.

There are two problems with this argument:

1. They don’t invest your money. Social Security is a pay-as-you-go system so your taxes aren’t saved and invested for your own use, rather they’re given out immediately to other retirees. Your future benefits will come from future workers’ taxes.
2. Benefit growth is significant. Your benefit increases 7% to 8% for every year you delay (plus cost of living increases on top of that).

Factors to consider before taking benefits

You can’t just add the numbers up and see which is bigger because that ignores important details that affect the final outcomes.

Can you afford to invest it?

If you need benefits to live on then take them and use them — that’s why they’re there.

Your income must be below a threshold

The Social Security Administration (SSA) doesn’t want you to double-dip, so if you take benefits at age 62 and still earn an income, they’ll reduce — or even eliminate — your benefits. $19,560 is the threshold this year. Earning more than that reduces your benefits until your reach your Full Retirement Age (FRA) of 67, after which you can earn as much as you like without penalty.

Taxes

If you have taxable income greater than $25,000 (individual) or $32,000 (married), then a portion of your benefits will be taxed. That too will reduce the growth potential of this approach.

Stock market performance

Historically the stock market returns 7% or more on your investments, but as we all know it can be frightfully volatile at times. Longer-term investments are more likely to be stable and positive, but your risk tolerance and investment style will influence the returns you achieve. Most people at retirement age are advised to take a more conservative approach to investing.

Then there’s that potential trust fund issue in 2033

Until a few years ago, the Social Security Administration collected more money from workers than they paid out to retirees. The surplus went into a trust fund for future use. Well, the future has arrived and now the taxes collected aren’t enough to pay all retiree obligations so they use the trust fund to cover the shortfall.

Unless the US Congress does something the trust fund will run out of surplus cash in 2033 and our benefits will be reduced by as much as 24%. That’s a life-crippling reduction for some people and a major annoyance for others.

Luckily there’s still time for Congress to make changes, and there’s every expectation that they will do something. To be safe, though, I’m taking this into account in the calculations below.

Methodology

The math behind the answer isn’t hard. There are three streams of income that grow over time. One starts at 62, another at 67, and the third at age 70. What we want to see is whether the streams that start at 67 or 70 ever catch up with and pass the age 62 stream.

There are three critical variables built into the calculations.

1. Rate of return: When you invest your benefits, you can take a wide range of positions, from conservative to aggressive. Investment risk is a personal decision that can have a significant impact on the outcome. So, I’m using three positions to illustrate the differences: 3%, 5%, and 7%.
2. Cost of Living Adjustments: The SSA adjusts benefits most years to reflect cost-of-living increases. All three income streams have been adjusted similarly so they match today and dozens of years into the future — so we’re comparing apples to apples.
3. Trust fund impact: I’m reducing benefits in all income streams by 12% (half of the worst-case possibility) starting in the year 2033. Given that we’re getting closer to the day of reckoning and Congress is still spinning its wheels, it’s likely that some modest impact will be felt in 2033. Best to plan for it.

A word on taxes: I have not included taxes in the equations because each of us has unique tax circumstances. A general rule is that if you do earn enough to pay taxes, then your investment growth from taking benefits early will be lower (making the delay to 67 or 70 even more beneficial than shown below).

Results

The program calculations end up with three charts that look like this one. Age is shown across the bottom and the lines show the growth of the three income streams as you age.

This chart shows that taking benefits early at age 62 (the blue line) is best only if you don’t expect to live beyond age 77.

In all scenarios tested, I found that delaying benefits provides more lifetime income — if you live long enough.

Three break-even points are the critical events that define your Social Security strategy

There are three seminal break-even points in your Social Security benefits strategy:

• When 67 beats 62
• When 70 beats 62, and
• When 70 finally beats 67

To simplify, I’ve created a grid that identifies the break-even points for each investment strategy. Ages are rounded off to the nearest year.

Conclusion

The idea of taking Social Security at age 62 and investing it is an intriguing idea, but if you manage to live into your 80s, it could be a costly gambit.

Delay them if you can, but take your benefits when you need them because that’s why they’re there. You can’t beat the house or game the system, so focus your energy instead on a plan to be happy and healthy in retirement.

Like in Vegas, you can’t beat the house

Regardless of which choice you make, your health is the most important factor in maximizing your Social Security benefits. The longer you live, the more you make.

So, live long and make a fortune!