Investing Social Security Benefits Not Worth the Risk

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.

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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.