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Taking Social Security Early and Investing the Money

After last week’s post about when to take Social Security benefits, a few people contacted me to ask what I think about taking the benefits early and investing them. [Quick note: This post is also regarding unmarried investors. I’m attempting to cover the simpler scenarios before moving on to the more complex ones.]

My answer was that it makes sense in some cases. Specifically, it depends on four factors (two knowable, two unknowable):

  • How long you’ll live,
  • What rate of return you’d earn if you invested the money,
  • What withdrawal rate you expect to need to use from your portfolio, and
  • Whether you care more about increasing the possibility of leaving a large inheritance or about reducing the possibility of outliving your money.

Let’s Try an Example

For a person born in 1950, for every $12,000 0f annual benefits at full retirement age, you could instead choose to get:

  • $9,000 per year (adjusted for inflation) at age 62, or
  • $15,840 per year (adjusted for inflation) at age 70.

So how does it play out if we compare the two following strategies?

Strategy 1: Delay benefits until age 70, at which point you claim benefits and spend the entire amount ($15,840) each year.

Strategy 2: Claim benefits at age 62 ($9,000 per year) and invest the money. Beginning at age 70, start spending $15,840 per year ($9,000 of benefits and $6,840 from the savings that have accumulated from claiming benefits early).

Using Low-Risk Investments

If we assume a 2% after-inflation return (approximately what you could expect to earn from low-risk investments like TIPS), the break-even point occurs shortly after turning 83.* That is, if you live past age 83, you’d be better off delaying benefits. If you die prior to age 83, you’d have been better off taking benefits early.

For reference, according to the Social Security Administration, the total life expectancy at age 62 is 81.2 for a male and 84.1 for a female. In other words, for very low risk investments, the break-even point is approximately the same as the average life expectancy.

What If We Use Riskier Investments?

If we assume, for example, a 4% after-inflation return, the break-even point occurs shortly before age 87. The takeaway here is that with a 4% real return, most investors would end up benefiting from claiming benefits early and investing them.

And indeed, a 4% after-inflation return does sound reasonable (to me, at least) for a moderately-allocated stock/bond portfolio.

But it’s not exactly a slam-dunk. Even if the investments in your portfolio earn a (time-weighted) average 4% annual after-inflation return, it’s possible that your return will be less due to sequence of returns risk.

The conclusion here is rather common sense: If you take something with very little risk (Social Security payments) and replace it with higher-risk investments (stocks and bonds), you will on average, end up with more money. But that comes at the cost of a higher risk (specifically, a higher risk of running out of money–depending on your withdrawal rate).

In Summary

As we discussed before, delaying Social Security retirement benefits is very much like buying an inflation-adjusted lifetime annuity (one with an unusually high payout and unusually low credit risk).

And much like buying an annuity, it makes a lot of sense if your goal is to maximize the amount you can spend per year while minimizing the risk of running out of money.

However, also like buying an annuity, it doesn’t make a lot of sense if a) you care a great deal about maximizing the size of the inheritance you leave to your heirs and b) you have enough savings to get by using a safe withdrawal rate from a portfolio of higher-risk investments (stocks, bonds, etc.).

*If you’d like to check my math (never a bad idea), here’s the spreadsheet I used.

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  1. But is that $9K gross distributions or net after taxes, and how would you determine your net benefit until you file your return after the year is over? Also, are you still working at age 62, which has some bearing on the tax you’re paying? The taxes are the most obvious element missing from your equations that I see.

  2. Hi Larry.

    You have a valid point, of course. I intentionally left taxes completely out of the calculations.

    For better or worse, I’m attempting to address everything one-topic at a time, as bundling everything into one article would be rather overwhelming (for me as a writer at least, if not for the reader).

    For example, just for single people, the following haven’t been addressed:
    -Taxes (which is a few sub-topics on its own),
    -Legislative uncertainty regarding SS benefits,
    -How things change depending on when you retire,
    -How averse you are to going back to work (as well as how possible it would be to do so, should you want to),
    -How willing you are to vary your spending from year to year.

    Then when we add in the fact that some people are married, we have:
    -How one spouse’s level of benefits compares to the other spouse’s, and
    -The difference in age/life expectancy between the spouses.

  3. OK, if this is a series of articles, I’ll just hold off until I see the remaining entries. . . .

  4. Just to clarify: My comment above wasn’t intended to discourage questions or discussion. Questions and comments are as appreciated as ever.

    My intention was simply to point out that I understand that I’m leaving out certain considerations, and that my goal is to cover them over time. 🙂

  5. I know!

  6. Mike, the answer to the question about taking the benefits early and investing them is very simple. If your more concerned with having more money if you’re dead than having more if you’re alive, take it early. Otherwise, wait.

    We can’t know what kind of return we’ll get, and we can’t know how long we’ll live. Whatever our returns end up being, we do know that the longer we live, the better off we will have been for waiting. I think the real question to be answered is: in which situation am I most concerned about stretching my dollars? In other words, if I die young with a chunk of money left over, do I want to have maximized the size of that chunk? Or, if I live really long, do I want to have maximized the amount of money I’ve got to keep living on?

  7. Well said, Dylan. Thank you. 🙂

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