By FPA member Jason K. Branning, CFP®
Last Updated: December 6, 2010
Have you ever thought about how you plan to use your Social Security benefits when you retire? If you have an answer, what led you to decide as you did? Perhaps you decided based on what family or friends did? Or, do you simply think that you will take your benefits at normal retirement age?
The Social Security Administration is 75 this year1. It is one of the most successful social programs in history. While successful, it is a very complicated, nuanced retirement program. Ultimately, retirees need a comprehensive framework to think about retirement planning decision-making. Otherwise, retirees may make ill-informed decisions about Social Security, and retirement which could have adverse consequences.
A larger framework exists in the premises of Modern Retirement Theory2. Delving into this alternative is beyond the scope of this article, but you may want to research this and others that offer comprehensive retirement planning context.
On the surface, the question of how you will use your Social Security benefits seems benign enough, but when you examine the implications of your decisions, the possible answers will actually unfold enormous complexity with lifestyle altering potential. You should be guided by your individual situation, not someone else’s. The real issue in determining when to take Social Security revolves around managing a retirement lifestyle through your lifetime or what financial planners and others refer to as “longevity.” So, how can you make sense of Social Security from an individually driven, comprehensive approach?
The Social Security Question
To bring clarity to your decision, one question may help illuminate the way you should move forward. Hamlet stated the question is: “to be or not to be”. With Social Security the question is: to “maximize payments” or to “maximize income”?
Let’s examine some of the rationale behind deciding in one direction or the other, because you must decide. It is a crucial decision.
Social Security as “Maximizing Payments”
If your goal is to maximize the total payments you will receive from Social Security, the logical conclusion is to take the benefits early, since individuals cannot predict their potential lifespan by using a life expectancy table. The focus is simply on getting as many payments as possible, with less regard for the actual monthly income you get. Underlying the drive to collect as many payments as possible is typically the thought that you may die without ever having accessed your benefits.
A “maximizing payment” perspective will likely prove the best solution if one is terminally ill, or if you have no other income due to your inability to work. No one can predict the best time to take Social Security, because predicting the date of an individual’s death is impossible. In a “maximizing payment” mindset, you must examine the break-even among benefits at various points from 62 to 70. You are placing a wager on your own mortality.
While knowing the break-even points is interesting; is it really helpful to your decision-making? You still have to decide why you are taking it at specific age. Are there other reasons to take the benefit early or later? The implication of choosing “maximizing payments” is simply because you think you will die by a certain age.
Table A: Social Security as Maximizing Payments — Comparison of Social Security Benefits Paid Out Annually and Sum of All Payments Received Based on Starting Ages 62, 66, and 70. Example uses a Normal Retirement Age of 66 and a Full Retirement Benefit Amount at Age 66 of $2,038 per month.
Social Security as “Maximizing Income”
If your goal is focused on sustaining your unknown lifespan in retirement, then maximizing total income is the logical solution. If you “maximize income” from Social Security based on your actual retirement expenses, the priority would be to use these inflation-adjusting payments to cover base expenses3. If Social Security benefits are perceived as retirement income designed to meet a higher percentage of your base expenses, the benefits can be viewed as your base expense coverage contribution4. The higher the base fund coverage contribution from Social Security, the more sustainable your retirement plan.
Base expenses should be matched to projected income that is contractually guaranteed and inflation adjusting (for example Social Security and the like). By matching an expense with a guaranteed income stream, you can more confidently cover your mandatory base expenses.
To achieve a higher base expense coverage contribution from Social Security, wait to collect benefits to receive your higher monthly income. By doing this you are: a) getting a higher income stream to be used to cover mandatory expenses that is inflation-adjusting, and b) preserving your purchasing power for the later retirement years.
Table B: Social Security Coverage Contribution4 of Base Expenses — Comparison of Social Security Benefits Paid Out Based on Start Date Versus Bases Expenses. Example uses a Normal Retirement Age of 66 and a Full Retirement Benefit Amount at Age 66 of $2,038 per month and Base Expenses of $2,000 per month with 2 percent inflation.
There are many variables that should be used to examine when you should take Social Security, which is why you need a comprehensive approach to answer your retirement question. Social Security may represent a significant portion of your overall retirement plan. Framing the question in terms of what Social Security is in your mind, “maximizing payments” or “maximizing income” will help you focus on what is of most importance to you.
Whether it is return of money from the system or possibly higher retirement lifestyle sustainability by waiting, this decision is complex and highly individual. Contact a qualified adviser to assist you in navigating your options and the implications throughout retirement.
Of note, seniors and others interested in saving Social Security should visit FPA’s Social Security Predictor, a web tool that allows you to compute your benefits based on your age and current projections for the future funding of the system.
1 Social Security Administration. http://www.ssa.gov/history/history.html
2 “Modern Retirement Theory”, Journal of Financial Planning’s Retirement Distribution Supplement, December 2009. Copyright Jason Branning, CFP®, and M. Ray Grubbs, Ph.D.
3 Base Expenses, as defined by Modern Retirement Theory, are mandatory living expenses of food, shelter, clothing, medical, transportation, and utilities.
4 Coverage Contribution, as defined by Modern Retirement Theory, is the contribution percentage that a third-party guaranteed income stream covers relative to Base Expenses.
FPA member Jason Branning, CFP®, is a fee-based investment adviser and financial planner with CS Planning Corp. in Ridgeland, Miss. He owns Branning Wealth Management LLC and serves as a board trustee to FPA of Mississippi.