Doing a break-even
analysis and other ways to decide how soon to start
By AMY FONTINELLE Updated Nov 24,
2019
TABLE OF CONTENTS
If you’re about to retire, you may be
wondering whether you should start claiming your hard-earned Social Security benefits. If you need the
income to support yourself and you’re at least 62—the minimum age to claim—the
answer could be obvious. But if you have enough other income to keep you going
until you’re older, how do you decide? Here are the key factors to consider.
KEY
TAKEAWAYS
·
You can collect Social
Security as early as age 62, but your benefits will be permanently reduced.
·
Doing a break-even
analysis can help you determine when you'd come out ahead by delaying benefits.
·
Spouses can also claim
benefits based on their partner's work record as early as age 62.
How Benefits Are
Calculated
In addition to how much you've earned over the
years, the size of your monthly Social Security benefit depends on when you
were born and the age at which you start claiming—down to the month. You'll
receive your full or normal monthly benefit if you start claiming when you
reach what Social Security considers your full retirement age. To find your
full retirement age, see the chart below.
What’s Your Full Social Security Retirement
Age?
|
Year
Of Birth
|
Full (Normal) Retirement Age
|
|
1937 or earlier
|
65
|
|
1938
|
65 and 2 months
|
|
1939
|
65 and 4 months
|
|
1940
|
65 and 6 months
|
|
1941
|
65 and 8 months
|
|
1942
|
65 and 10 months
|
|
1943–1954
|
66
|
|
1955
|
66 and 2 months
|
|
1956
|
66 and 4 months
|
|
1957
|
66 and 6 months
|
|
1958
|
66 and 8 months
|
|
1959
|
66 and 10 months
|
|
1960 and later
|
67
|
Let’s say your full retirement age is 66. If
you start claiming benefits at 66 and your full monthly benefit is $2,000,
you’ll get $2,000 per month. If you start claiming benefits at age 62, which is
48 months early, your benefit will be reduced to 75% of your full monthly
benefit—also called your primary insurance amount. In other words, you’ll get
25% less per month and your check will be $1,500.
You’ll continue to receive a reduced benefit
not just until you turn 66, but for the rest of your life, though it will go up
slightly over time with cost-of-living adjustments. You can do the math for
your own situation using the Social Security Administration (SSA) Early or Late Retirement calculator (scroll
down the linked page to find it).
If you wait until you’re 70 to start claiming
benefits, you’ll get an extra 8% per year, or, in total, 132% of your primary
insurance amount ($2,640 per month in the example above) for the rest of your
life. Claiming after you turn 70 doesn’t increase your benefits further, so
there’s no reason to wait any longer.
The SSA’s online retirement calculators can also help you
determine your full retirement age, the SSA’s estimate of your life expectancy
for benefit calculations, rough estimates of your retirement benefits,
individualized projections of your benefits based on your personal work record,
and more.
The longer you can afford to wait—up to 70—the
larger your monthly benefit will be. But delaying benefits doesn’t necessarily
mean you’ll come out ahead overall. You'll also need to weigh in some other
factors including your expected longevity, and whether you or your spouse plan
to file for spousal benefits. You will also need to consider the tax,
investment opportunity, and health coverage implications.
Your Likely Longevity
So much of our strategy on how to maximize
Social Security retirement benefits depends on guesses of how long we’ll live.
Of course, any of us could die in an accident or get a dire diagnosis next
week. But putting aside these unpredictable possibilities, how long do you
think you’ll live? How are your blood pressure, cholesterol, weight, and other
health markers? How long have your parents and other relatives lived? If you
foresee an above-average life expectancy for yourself, you may come out ahead
by waiting to claim benefits. If not, you may want to claim your benefits as
soon as you’re eligible.
To make an educated guess about when to claim,
try doing a break-even analysis. That will tell you when
the total benefits you'd receive by waiting will begin to exceed the total
you'd receive by taking benefits earlier. For example, if you'd get $1,500 a
month starting at age 62 or $2,000 a month starting at age 66 you will have
received roughly the same amount in total benefits by age 77 or so. At that
point, the higher monthly benefits you'd get as a result of waiting will begin
to pay off.
The Social Security website will tell you
that, regardless of when you start claiming, your lifetime benefits will be
similar if you live as long as the average retiree. The problem is that most
people will not have an average life expectancy, hence all the different
claiming strategies.
Claiming Spousal
Benefits
Being married can further complicate the
decision of when to take Social Security because of the program’s spousal benefits. Some divorcees are also entitled to benefits
based on their ex-spouse's work record.
Spouses who didn’t work at a paid job or who
didn’t earn enough credits to qualify for Social Security on their own are
eligible to receive benefits starting at age 62 based on their spouse’s
record. As with claiming benefits on your own record, your spousal benefit will
be reduced if you take it before reaching full retirement age. The highest
spousal benefit you can receive is half the benefit your spouse is entitled to
at their full retirement age.
While spouses get a lower benefit if they
claim before reaching their own full retirement age, they will not get a larger
spousal benefit by waiting to claim after full retirement age—say, at age 70.
But a nonworking or lower-earning spouse may get a larger spousal benefit if
the working spouse has some late-career, high-earning years that boost their
benefits.
When one spouse dies, the surviving spouse is
entitled to receive the higher of their own benefit or their deceased spouse’s
benefit. That’s why financial planners often advise the higher-earning spouse
to delay claiming. If the higher-earning spouse dies first, the surviving,
lower-earning spouse will receive a larger Social Security check for life.
When the surviving spouse hasn’t reached full
retirement age, he or she will be entitled to prorated amounts starting at age
60. At their full retirement age, the surviving spouse is entitled to 100% of
the deceased spouse’s benefit or to their own benefit, whichever is higher.
Note that the claiming strategy called file and suspend, which allowed married
couples of full retirement age to receive spousal benefits and delayed
retirement credits at the same time, ended as of May 1, 2016. However, spouses
born before January 2, 1954, who have attained their full retirement age may
still be able to file a restricted application. It allows them to
claim spousal benefits while delaying their own benefits up to age 70.
Taxes on Your Benefits
Your Social Security benefits may be partially
taxable if your combined income exceeds certain thresholds. Regardless of how
much you make, the first 15% of your benefits are not taxed.
The Social Security Administration defines
combined income using this formula:
Your adjusted
gross income
+ Nontaxable interest (for example, municipal bond interest) + ½ of your Social Security benefits = Your combined income
+ Nontaxable interest (for example, municipal bond interest) + ½ of your Social Security benefits = Your combined income
If you file your federal tax return as an
individual and your combined income is between $25,000 and $34,000, you may
have to pay income tax on up to 50% of your benefits. If your combined income
is more than $34,000, you may have to pay tax on up to 85% of your benefits.
If you’re married filing a joint return and
your combined income is $32,000 to $44,000, you may have to pay income tax on
up to 50% of your benefits. If your combined income is more than $44,000, you
may have to pay tax on up to 85% of your benefits. One way to determine your
tax liability is to use an online tool like the Motley Fool’s Social Security tax
calculator (scroll down the page after clicking the link).
Let’s say you receive the maximum Social Security benefit for
a worker retiring at full retirement age in 2020: $3,011 per month. Your spouse
receives half as much, or $1,505.50 a month. Together, you receive $4,516.50 a
month, or $54,198 per year. Half of that, or $27,099, counts toward your
“combined income” for determining whether you have to pay tax on part of your
Social Security benefits. Let’s further assume you don’t have any nontaxable interest,
wages, or other income except for your traditional IRA’s required minimum distribution (RMD) of
$10,000 for the year.
Your combined income would be $35,746—half of
your Social Security income plus your IRA distribution—which would make up to
50% of your Social Security benefits taxable because you've exceeded the
$32,000 threshold. Now, you may be thinking, "50% of $54,198 is $27,099,
and I’m in the 12% marginal tax bracket, so the tax on my Social Security
benefits will be $3,251.88." Fortunately, the calculation takes other
factors into account, and your tax would really be a mere $225. You can read
all about the taxation of Social Security benefits in IRS Publication 915.
Tax Considerations For
Social Security Benefits
How do these tax considerations affect when
you should apply for Social Security benefits? At today's marginal tax rates, they may not have much of
an impact for most people. But tax rates and income thresholds can change. So
it's worth remembering that you will lose less of your Social Security to taxes
if you are in a lower marginal tax bracket when you begin to collect.
Also note that if you decide to return to
work, even part time, and aren't yet of full retirement age, your Social
Security benefits may be temporarily reduced. The reduction is $1 for every $2
of earned income over $18,240 (in 2020).
During the year in which you reach full retirement age, your benefits will be
reduced by $1 for every $3 in income over $48,600 (in 2020), until the month
you become fully eligible. That money isn't lost, however. The SSA will credit
it to your record when you reach full retirement age, resulting in a higher
benefit.
Investing Your
Benefits
Are you a disciplined, savvy investor who
thinks you could earn more by claiming early and investing your benefits than by
claiming later and receiving Social Security’s guaranteed higher benefits? Then
you may want to claim early instead of waiting until age 70.
Most investors, however, are neither
disciplined nor savvy. People take early benefits intending to invest the money,
then use it to tour Europe (or pay everyday bills) instead. And even savvy
investors can't predict how their investments will perform, especially in the
short term.
If you claim early, invest in the stock market
and average an 8% annual return—which is far from guaranteed—you will almost
certainly come out ahead compared with claiming late, according to an analysis by Dan Caplinger,
director of investment planning for Motley Fool. But if your returns are lower,
if you receive reduced Social Security benefits because you continue working
past age 62, if you have to pay taxes on your Social Security income, or if you
have a spouse who would benefit from claiming Social Security benefits based on
your record, then all bets are off. Most people, in other words, will not
benefit from this strategy—but it is a strategy to be aware of in case you’re
one of the few who might.
Claiming Social
Security benefits could make you ineligible to put more money into a Health
Savings Account (HSA).
Timing and Your Health
Coverage
Your health insurance coverage can also play a
role in deciding when to claim Social Security benefits.
For example, do you have a health
savings account (HSA) that you would like to keep contributing
to? If so, note that if you’re 65 or older, receiving Social Security benefits
requires you to sign up for Medicare Part A. But once you sign up for Medicare
Part A, you’ll no longer be allowed to add funds to your HSA.
The Social Security Administration also
cautions that even if you delay receiving Social Security benefits until after
age 65, you might still need to apply for Medicare benefits within three months of
turning 65 to avoid paying higher premiums for life for Medicare Part B and
Part D. If you are still receiving health insurance from your or your spouse's
employer, however, you might not have to enroll in Medicare yet.
The Bottom Line
You don’t have to take Social Security just
because you’re retired. If you can live without the income until age 70, you
will ensure the maximum payment for yourself and lock in the maximum spousal
benefit. Just be sure you have enough other income to keep you going and that
your health is good enough that you are likely to benefit from the wait. When
you’re ready, you can apply for benefits online, by phone, or at your local
Social Security office.
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