For most clients, delaying collection is by far the best way to maximize lifetime Social Security income. According to a report by Boston College’s Center for Retirement Research, however, roughly 42 percent of men and 48 percent of women still claim at 62, and the average collection age is 64. Nationwide Retirement Institute research shows future retirees are intending to collect later, but when push comes to shove, many people want their benefits as soon as possible.
Why are so many Americans taking a conscious pay cut?
“It’s behavioral finance,” says Hans Scheil, CEO of Cardinal Retirement Planning. “They want the security of knowing a government check is coming instead of just living on their assets.”
Others are worried the government will cut benefits by the time they start collecting; some face a short-term cash crunch following a layoff or cross-country move.
Many of these reasons are more emotional than rational, but there are a few cases in which collecting early makes sense. Here are a few considerations to keep in mind when your clients are on the fence.
Getting the facts straight
Most seniors understand that the earlier they collect, the lower their monthly checks will be.
“What they don’t understand is the magnitude of the situation,” says Gail Buckner, financial planning spokesperson for Franklin Templeton. For anyone with a full retirement age of 66, collecting at 62 ½ nets a 25 percent lifetime benefits reduction, while delaying until 70 offers a 32 percent credit.
For younger retirees, penalties are more severe and credits less beneficial. Clients with an FRA of 67 – those born 1960 and after – will be penalized by 30 percent for collecting at 62, and they’ll only get a 24 percent credit for collecting at 70. They won’t be able to collect until 2022, but learning these numbers in advance may influence their work and investment plans in the meantime.
Low life expectancy
“If, for some reason, someone believes they won’t live until life expectancy, it absolutely makes sense to draw early,” says James Sullivan, vice president of Essex Financial.
In cases of terminal illness and family histories of early death, it may make sense for a client to collect while they can.
Still, even health concerns may not justify early collection – particularly for married clients.
“You’ve got to consider long-term care needs and survivor planning,” says Scheil. “The average cost for assisted living is around $4,500 per month in our area, and people who collect early don’t save their money for this kind of scenario.”
If a client draws early, lives longer than expected and eventually needs long term care, they’ll be in quite a bind.
Another common concern involves high-earning breadwinners and their spouses. Even if the high earner is likely to die young, their spouse may live to a ripe old age. Widows and widowers are entitled to 100 percent of their deceased spouses’ benefits, but if that spouse has already collected early, the survivor is stuck with the penalty.
Another common reason for collecting early is that some people simple need the money. They may have been laid off, retired too early or didn’t save enough, says Scheil. In fact, 68 percent of recent retirees who filed early did so to pay living expenses, and 43 percent needed to supplement their income. Similarly, 21 percent filed early to pay health care costs their other assets couldn’t cover.
“For some people, working is actually making their health worse,” adds Sullivan.
It might make actuarial sense for a client to keep working until 66, but if a stressful job would lead to higher future health care costs and a decreased quality of life, retiring immediately and collecting early could be a better choice.
In those situations, however, the client will have to spend their already reduced Social Security income on private health insurance. As of now, a consumer in their 60s can’t be charged more than three times a much as a 20-year-old’s premium, but that ratio will change to 5 to 1 if the ACHA passes in its current form. Ultimately, a client’s age, COBRA coverage and current assets must be taken into account in order to determine whether early filing makes sense.
Cash flow concerns aside, some seniors collect early to invest. With a 5 percent “return” between 62 and 66 and 8 percent between 66 and 70, however, beating Social Security is a tall order.
“The calculation that really needs to be run is the benefit’s net present value, though,” says independent investment consultant Ilene Davis. “You also have to take into account the time value of money, which is the part many advisors miss.”
Unlike most other assets, Social Security is actually worth more when inflation is high and interest rates low, making it all the more valuable to retirees. So what can beat it?
“You might use Social Security to pay for a hybrid life policy,” says Doug Amis, president and COO of Cardinal Retirement Planning. “Using today’s rates, a 65-year old female client could purchase an $11,500 policy that provides $500,000 of tax-free death benefit or $10,000 of long-term care coverage per month for 50 months plus $50,000 to beneficiaries.”
Even if that client lived all the way to 90, they’d realize a 4.19 percent rate of return.
“For a client who doesn’t need Social Security for retirement expenses, this option provides an excellent way to protect against long-term care expenses and maximize their legacy to heirs,” Amis adds.
When it comes to equities, though, most clients are better off waiting. “You have to make some pretty optimistic assumptions to think you’ll get a better return, and we try to dispel clients of that idea,” says Sullivan.
Finally, with 63 percent of recent retirees and 68 percent of future retirees worried that Social Security will run out of funding, many clients collect early in an attempt to get what they can. For those with the assets to self-fund the first few years of retirement, this ill-informed strategy will only lead to a lower lifetime benefit.
While the most recent Trustee Reports do say the trust fund will be depleted by 2034, most consumers aren’t getting the full story. The SSA’s bonds and bond interest are projected to be depleted by 2034. At that point, the administration will have to pay out benefits purely with payroll taxes. Those taxes are estimated to cover 79 percent of promised benefits, but a 2.66 percent bump in the payroll tax – 1.33 percent for employer and employee – would cover the difference for 75 years.
Congress last increased the tax in 1983, just before the actuarial deficit would have affected payouts. Tax hikes aren’t popular, to be sure, but with 17 years left to address the problem, it seems safe for the current crop of retirees to count on full benefits.
Taxes, however, might be a different story.
“I expect by 2030, 100 percent of Social Security benefits will be taxed,” says Davis.
For people on extreme ends of the income spectrum, it might make sense to collect early. Some need their checks in the short term to cover retirement expenses, while others can use their reduced benefits to buy life insurance, better preserving their assets and legacies in the process.
For most clients, though, delaying collection is still the best bet. With the FRA rising, life expectancies growing and potential Social Security tax increases on the horizon, that 8 percent-per-year boost is critical for maximizing lifetimeSocial Security income. With a better understanding of the specifics, clients will be more likely to make sound decisions – even if that means drawing down other assets while they wait.