Personal Finance: Breakeven Analysis and Timing the Start of Social Security Benefits

Wednesday, March 11, 2015

Joe Alfonso, GoLocalPDX Contributor

The decision as to when to begin taking Social Security retirement benefits is critical and greatly impacts the ultimate size of the benefit received. If you wait until your full retirement age (FRA) to claim a retirement benefit you are guaranteed to receive the full monthly benefit you are entitled to based on your career earnings. You can claim a retirement benefit as early as age 62, but if your FRA is 66, your monthly benefit will be reduced by 25%, and this reduction is permanent. The flip side is that you can delay claiming your retirement benefit past FRA. For each year that you delay up until age 70 you will receive an 8% credit. If your FRA is 66, delaying to age 70 will result in a 32% increase in your monthly benefit compared to the age 66 benefit.

Delaying the start of Social Security benefits clearly results in higher monthly benefits, but there is a cost for waiting. In exchange for receiving bigger checks later you will forgo receiving smaller checks sooner and for a longer time. Eventually, however, the cumulative income earned by those who wait catches up and exceeds that earned by the early starters, assuming the delayers live long enough. This is known as the breakeven age.

At the macro level, the Social Security benefit system is based on actuarial data and average longevity for the population as a whole. Given average life expectancy, the relative cost for paying out early claims for more years compared to that for paying higher delayed benefits for fewer years is the same. At the individual level, few claimants’ life spans exactly match the average for the population as whole so an idiosyncratic analysis is required.

It turns out that the breakeven age at which a 70 year old claimant overtakes an age 62 claimant, assuming 2% annual cost of living adjustments, is 78. For current 65 old males, the likelihood of living to at least age 78 is approximately 60%, based on the 2010 Social Security Mortality Tables. It is therefore advantageous for a single person who expects to have at least a normal life expectancy to delay, if possible.

Breakeven analysis can be a useful tool to help you decide when to begin claiming benefits. Like all tools, however, it needs to be used properly or it can lead to bad decision making.

Breakeven analysis is not appropriate for married couples given the impact of another Social Security benefit, the survivor benefit. A survivor benefit is paid to the surviving spouse in a marriage and is based on the retirement benefit of the higher earning spouse. If both spouses were receiving their own retirement benefit at the death of the first spouse, the lower of the two retirement benefits drops and the surviving spouse receives the higher benefit for the rest of his or her life.

Given that retirement benefits earn delayed retirement credits up to age 70 it is imperative for the higher earning spouse to delay taking their retirement benefit even if their expected life expectancy is shorter than normal. As long as that spouse lives past FRA, and hopefully to age 70, delaying will result in a higher survivor benefit. Based on the same Social Security Mortality Tables for a 65 year old married couple, there is a 50% chance of one spouse living past age 88. The need to maximize the lifetime income for a surviving spouse who may live well into his or her 80s and beyond is the key factor that should drive the claiming decision for the higher earning spouse and not a breakeven analysis measured against individual life expectancy.

Deciding when to start your Social Security retirement benefit is critical. Using breakeven analysis where appropriate can greatly assist you in this process. In any case, remember that Social Security is in many respects a form of “longevity insurance” that can help reduce the risk of running out of money during our lifetimes. Since we are all living longer than at any time in the past, it behooves us to maximize our benefits as much possible by taking advantage of the delaying opportunities allowed under the Social Security system rules.

Readers with questions on personal finance and Social Security can email Joe Alfonso at [email protected].

Joe Alfonso, CFP®, ChFC, EA regularly writes on financial topics and is an expert on Social Security planning. He is founder of the Fee-Only financial planning firm Aegis Financial Advisory in Lake Oswego, Ore., and is the principal advisor for the firm. Joe is a CERTIFIED FINANCIAL PLANNER™ professional and an Enrolled Agent, admitted to practice before the IRS to represent taxpayers at all administrative levels for audits, collections, and appeals. He is a member of The National Association of Personal Financial Advisors (NAPFA).