On paper, it seems pretty obvious that the best way to optimize your retirement is to delay claiming Social Security for as long as possible.
According to the Social Security Administration, receiving your benefits as early as possible (age 62 for those born after 1960) could result in lower monthly payments. At age 67, you qualify for full benefits, but if you delay your claim until age 70, you could enjoy a full 24% increase in monthly benefits. At age 70 your monthly benefit stops increasing.
With this in mind, many financial planners recommend delaying claims for benefits as long as possible until age 70. However, this relatively simple math overlooks some key variables that might surprise some retirement planners.
“Age 70 is not the most financially rewarding age to start benefits unless a person has a low discount rate and/or is confident they will live several years beyond their life expectancy,” says an article published in the Journal of Financial Planning by two financial experts. (1) The discount rate is the expected average rate of return that tells us the present value of future payments. It is used to decide if it is worth waiting for Social Security.
They said their calculations “do not support the presumption that the vast majority of people who choose to begin receiving their Social Security retirement benefits before age 70 are making a mistake.”
Here’s the updated math that some academics are using to suggest that early retirement might be a better option for some.
While they recommend delayed benefits, academics and economists use simple, generalized assumptions that do not fully reflect the reality of most retirees. So says Derek Tharp, financial advisor and associate professor of finance at the University of Southern Maine.
In an article published in The Wall Street Journal, Tharp argues that this simple spreadsheet calculation assumes that “future dollars are worth about the same as today’s dollars” (2). This assumption is based on another assumption: that a retiree invests primarily in ultra-safe assets that earn little or no return after inflation.
In doing so, economists have missed the opportunity cost, which is the return on the forgone option.
“Most people do not have portfolios consisting of assets that earn only 0% to 2%. Rather, their portfolios contain a mix of stocks and bonds, which have historically earned about 5% above inflation,” he wrote. “This difference is not a matter of trivial academic assumptions. Assuming that you will earn about 5% rather than less than 2% of Social Security income can completely change the math; it makes delaying benefits much less attractive.”
Read more: Are you richer than you think? 5 clear signs that you are head and shoulders above the average American
Retirees waiting to claim Social Security may also need to withdraw their savings and investments to cover living expenses, harming their savings and future returns.
Another risk of delayed benefits is mortality, according to Tharp. Life expectancy is 78.4 years, according to the Center for Disease Control (CDC), but your individual life expectancy could be different from this broad average. If you die prematurely, you could “leave hundreds of thousands of dollars on the table that otherwise could have been spent or donated to loved ones or causes you care about,” Tharp says.
To account for these risks, he recommends using a higher discount rate when calculating the present value of future benefits.
“Retirees with modest portfolios, health problems, or a propensity to spend less may see effective discount rates of 6% to 8% or more, heavily tilting the decision toward early filing,” he writes in an article for Kitces (3). “In contrast, retirees with substantial resources who are less vulnerable to policy or sequence of returns risks may still benefit from delaying until age 70.”
In addition to the math, there are also lifestyle factors that many retirees overlook when making this crucial decision.
Using a higher discount rate, as Tharp suggests, could help you capture all the financial risks you face as you decide when to start claiming Social Security benefits. But it doesn’t capture the lifestyle factors that are crucial to this decision.
A dollar is not only worth more today than tomorrow, it is also more flexible. Income at age 60 is much more useful than at age 80, when your health and mobility may be restricted. The average healthy life expectancy in the U.S. is just 63.9 years, according to the World Health Organization, so there’s a chance you’ve lost some of the best years of your retirement if you delay benefits until your 70s.
These factors could explain why the average retirement age in the U.S. is 62, according to MassMutual (4), and why only 10% of retirees wait until age 70 to claim benefits, according to the Bipartisan Policy Center’s analysis of SSA data (5).
A simple spreadsheet calculation doesn’t capture all the risks and nuances of your personal finances. Instead of delaying Social Security as long as possible, use better assumptions and a higher discount rate to calculate the actual present value of future benefit cash flows. Additionally, consider working with a professional financial planner to customize your retirement plan and optimize decisions for your desired lifestyle.
We rely only on verified sources and credible third-party reports. For more information, see our editorial guidelines and ethics.
Financial Planning Magazine (1); The Wall Street Journal (2); Kitces (3); MassMutual Retirement Happiness Study (4); Bipartisan Policy Center (5)
This article provides information only and should not be construed as advice. It is provided without warranty of any kind.
