EDITOR'S NOTE: This article was originally published in the March 2011 issue of Kiplinger's Retirement Report. To subscribe, click here.
Every so often, a reader asks Retirement Report whether it makes sense to take Social Security benefits early and invest them. The answer: No, it usually doesn't.
Consider the findings in a T. Rowe Price study. The firm compared investing benefits at age 62 versus delaying benefits until age 70. By delaying, the beneficiary receives $679,000 in after-tax benefits by age 85. Compare that to someone who sets aside benefits received from age 62 to age 69 until age 85 at an annual after-tax return of 5.45%. If that person spends the benefits he gets from age 70 to age 85, he gets a total of $767,000 -- $395,000 from the invested reserve and $372,000 in spent benefits.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
That early investor, though, will not be able to touch the reserve for decades. If he needs the money earlier, he may end up with less total income from Social Security than the beneficiary who delayed until 70.
Your choice could depend on your goals. Do you want to build a nest egg for future long-term-care expenses or perhaps leave the money to heirs? Or do you want to ensure a higher income stream for the future by delaying?
When you take benefits at 62, you're betting that you will die before the "break-even age" -- when the total value of full benefits equals what you would have received by claiming reduced benefits earlier. The later the break-even age, the more it makes sense to take benefits early.
The break-even age is about 78. But if you claim early and invest the benefits, you may be able to push back the break-even age, says Elaine Floyd, director of retirement and life planning for Horsesmouth, a consulting firm that works with financial advisers. She created a calculator that looks at what happens if you reinvest benefits.
If you claim early and invest, the new break-even age depends on the rate of return. Consider a person whose benefit at full retirement age would be $2,200 and is adjusted 2.8% annually for inflation. If that beneficiary takes reduced benefits at 62 and invests at a 4% rate of return, the break-even age is 81. Increase the annual return to 6%, and the break-even age is 84. At 8%, the break-even rises to 90.
But, says Floyd, a consistent rate of return is theoretical. "No investment I know of pays a consistent 8% for 30 years," she says. And if you don't get your planned returns, you could end up short on cash at 85 or 90. If the person above takes reduced benefits at 62, he will receive $3,974 a month by age 90, compared with $6,708 a month if he delays until 70, she says.
Holes in the Theory
There are pitfalls to investing early benefits. If you're still working, your benefits will be subject to the earnings test until full retirement age. While Social Security will then adjust your benefit to account for those forfeited benefits, you won't have had that money to invest in the meantime.
Also, by investing your benefits, you're subjecting a stable stream of income to the whims of the market. Every year you delay, Social Security formulas increase your benefit at a guaranteed amount, in addition to cost-of-living adjustments. "If I take benefits from the government early, I've got to be assured that I can get some healthy returns on my investments," says Christine Fahlund, senior financial planner for T. Rowe Price. "With Social Security, there's a formula -- you know the rules."
For invested benefits to grow, you must keep your hands out of that pot. Alan Ungar, a certified financial planner with Critical Capital Management, in Calabasas, Cal., says clients who have taken benefits early have ended up spending the money. "While the numbers may justify early distribution, human behavior screws things up," he says.
If you are married, think twice about claiming early. The longer a higher-earning spouse delays, the larger the survivor benefit will be for the lower-earning spouse. The survivor benefit is worth 100% of the higher earner's benefit.
-
Donating Complex Assets Doesn't Have to Be ComplicatedIf you're looking to donate less-conventional assets but don't know where to start, this charity executive has answers, such as considering a donor-advised fund (DAF) for its tax benefits and ease of use.
-
Travel trends you can expect this summerThe Kiplinger Letter Domestic trips will trump foreign travel amid economic uncertainties, though some costs are down.
-
457 Plan Contribution Limits for 2025Retirement plans There are higher 457 plan contribution limits for state and local government workers in 2025. That's good news for state and local government employees.
-
Medicare Basics: 12 Things You Need to KnowMedicare There's Medicare Part A, Part B, Part D, Medigap plans, Medicare Advantage plans and so on. We sort out the confusion about signing up for Medicare — and much more.
-
The Seven Worst Assets to Leave Your Kids or Grandkidsinheritance Leaving these assets to your loved ones may be more trouble than it’s worth. Here's how to avoid adding to their grief after you're gone.
-
SEP IRA Contribution Limits for 2025SEP IRA A good option for small business owners, SEP IRAs allow individual annual contributions of as much as $70,000 in 2025, up from $69,000 in 2024.
-
Roth IRA Contribution Limits for 2025Roth IRAs Roth IRA contribution limits have gone up. Here's what you need to know.
-
SIMPLE IRA Contribution Limits for 2025simple IRA The SIMPLE IRA contribution limit increased by $500 for 2025. Workers at small businesses can contribute up to $16,500 or $20,000 if 50 or over and $21,750 if 60-63.
-
457 Contribution Limits for 2024
retirement plans State and local government workers can contribute more to their 457 plans in 2024 than in 2023.
-
Roth 401(k) Contribution Limits for 2025retirement plans The Roth 401(k) contribution limit for 2025 increased, and workers who are 50 and older can save even more.
