When to Begin Social Security? Even Advisors Aren’t Sure

Social SecurityMy Comments: It’s hard for me to understand why this should be a difficult calculation. Until I realize that there are lots of variables in how social security benefits are payable, and the best solution is often a function of how long you live, and whether you and your spouse, assuming you have one, stay together or get divorced. And whether when one of you dies, whether or not there is a former spouse still alive, who may or may not be age 62 or more when your spouse dies. And so on.

The net effect is that it’s difficult to be sure.

By John Sullivan, AdvisorOne | March 28, 2013

Here’s a scary thought; Social Security is the largest source of retirement income for most Americans.

Routinely referred to by politicians and policymakers as a safety net to supplement other sources of retirement income, the sad reality is too many older Americans rely on it outright.

Just as troubling is the apparent confusion over when to begin taking Social Security payments—confusion that extends beyond recipients to the advisors themselves.

A recent paper from David Blanchett, head of retirement research with Morningstar, seeks to dispel that confusion. Blanchett and his team performed three claiming scenarios: receiving benefits early (e.g., at age 62 versus 66); delaying benefits past full retirement age (e.g., age 66 versus 70); and the maximum realistic delay period (e.g., at age 62 versus 70).

The results suggested it’s best not to begin taking benefits early, and if clients do, they should not “play with their own money” by attempting to invest it for a higher return than they would have received by waiting.

“Most retirees would be best served delaying Social Security benefits until at least full retirement age or later, and that delayed benefits are especially valuable for females, married couples, retirees who expect to invest in relatively conservative portfolios during retirement and retirees who have longer life expectancies,” Blanchett reported.

The effective return achieved by a retiree from making the optimal Social Security decision can “significantly exceed the return he or she could potentially earn by investing the money received from starting benefits earlier and ‘investing the difference,’ especially in today’s low interest rate environment,” he added.

Blanchett found the optimal Social Security claiming decision can generate 9.15% more income for a hypothetical retired married couple, which creates an annual equivalent “financial planning alpha” (or gamma) of +0.74% per year.

He also found an investor would likely need to earn an annual nominal compounded rate of return, net of fees, of more than 7% to be better off claiming benefits early.

“Delayed Social Security benefits can enable an investor to effectively achieve a rate of return that is much greater than they are likely to earn in the market,” Blanchett concluded. “Social Security benefits can also provide a valuable hedge against longevity risk and offer a form of protection from the adverse effects of cognitive decline at older ages.”