Speaker: Five reasons we commonly hear why you should take Social Security early and why we feel only three of them are actually justified. I had a conversation with Ed Rossi. Ed Rossi is a National Social Security Adviser. He’s one of our financial advisors here at Oak Harvest. He recently did our Social Security workshop and webinar. You can see on our website. Ed knows more about Social Security than any person I’ve ever met in my life.
We had a conversation, and we actually came up with about eight or nine common reasons that we hear of why you want to take Social Security early. I decided to focus on five, because one, I don’t want this video to be an hour long, and two, we could really go down many different rabbit holes when we’re looking at various analyses of different age and life expectancy, and income levels, spending goals, asset base, a lot of different options there, and in order to cover all of them, we’d have to go into that. We want to cover the top five most common reasons of why you should take Social Security early, but also understand what could go wrong, how this could all collapse if you don’t understand these key facts.
A Few Base Assumptions
We want to start with a few base assumptions here. If you’re going to take it early, you’re probably around the age of 62. At age 62, if you qualify for the maximum retirement benefit, you’re around $2,500 per month, that’s your maximum Social Security benefit. 83 life expectancy, because someone who is thinking about taking it early, doesn’t plan on living to be 95 or 96. Then we wanted to start with something realistic here a $4,000 per month spending goal. We’re going to look at a couple different asset levels here, but we’re going to start with someone who has $700,000 saved for retirement–$500,000 in IRA, $200,000 in non-qual, single, not married.
We’re going to take that consideration out of the picture because if you are married, one of the big considerations is, if you die younger, then your spouse receives the higher of the two Social Security benefits. For the purpose of this analysis, we’re just looking at someone who’s single.
Reason Number 1
Reason number one, you’re expecting a shorter-than-normal life expectancy. This is a valid reason to take Social Security early if you end up on the right side of that decision.
Here we see the analysis of taking it early, versus a delayed retirement strategy, where we’re going to wait until age 70. I want to show you this because two things. One, the crossover point here doesn’t happen until about age 78 or 79. If you live past 78 or 79, you will receive more from Social Security by deferring until age 70, then you will age 62, but if you only live until, let’s say 70 years old, we’re looking at about $216,000, maybe $230,000 received from Social Security if you took it at 62, versus if you had waited until age 70. Clearly, if you’re not going to live a very long time for health reasons, or whatever it may be, then taking it early mathematically does make sense.
Reason Number 2
Reason number two, you want to keep more money inside of your savings and investments, so you decide to take Social Security sooner. Okay, same parameters that we discussed earlier. We see visually, quite clearly, it does make sense in the beginning years to take from Social Security because the blue line here is an optimized distribution and tax strategy for retirement, versus the green line is simply showing the estimated account balances for taking Social Security early, and then following the conventional wisdom sequence. Conventional wisdom is you let your retirement accounts defer. The $500,000 in IRAs are being deferred here. They’re spending down to $200,000 in non-IRA savings. Remember at the beginning, same parameters, $700,000 total savings.
We see quite clearly that your asset base stays elevated because you’re taking Social Security to meet that $4,000 a month spending goal. What we actually see here is, while the strategy makes sense in the beginning years, because your Social Security check is so much smaller than if you would have otherwise deferred it later in life due to inflation, you have to start taking more out of your savings, so your green line goes down, and then the blue line here increases. You have higher account balances for taking Social Security later in life. I just want to show you that a bit more closely on the ledger.
Over here, we have what would be the primary income distribution and tax scenario. Just want to focus on this column and this column. Here we have Social Security, even at a life expectancy of age 83. It still makes sense to defer Social Security until 70 if we’re looking at optimizing our income, tax strategy, and Social Security strategy, and then the before-tax balance. If we take Social Security early, here’s your base strategy following conventional wisdom, we take Social Security, and we preserve our account balances, so 700,000 here, versus 592, drops to 510, gets into the 400,000 before we turn Social Security on.
Over here, we stay pretty elevated with our account balances for many years in the beginning of retirement. As we see, as we get out here to life expectancy age 83, our balance, now it starts to increase back up, that combined with a much higher Social Security income, 36,000 versus 61 or 62, optimizing your Social Security distribution and tax strategy results in a higher level of guaranteed lifetime income from Social Security, higher account balances later in life, and all of this equates to much more security for you.
When we compare over here. Let’s look at age 76, Social Security at 63, account balances of 584, versus Social Security at 37, account balances of 605. Right here, 77, 78 years old is when this asset base crossover point occurs where you have less money because you took Social Security earlier, and therefore inflation has caused you to take more money out of your accounts. You have less of an asset base than over here, the deferred strategy, and significantly less guaranteed lifetime income.
One of the foundations of a secure retirement is the ability to have income sources, multiple streams of income coming in that will be provided to you irrespective of the stock market’s performance. This guaranteed lifetime income from Social Security is a strong part of an overall foundation of a secure retirement.
One other thing to point out here, and I’m not going to go down this rabbit hole today, we do have a lot of videos out here that talk about it, the taxes. This column is your estimated taxes. I just want to show you this. Total taxes with the optimized strategy, we’re paying some taxes in the beginning years of retirement versus the conventional wisdom.
We’re really paying no taxes for a long period of time, looks like more than 10 years. Then what happens is we start to pay more taxes a little bit later in life. Cumulatively, 63,000 in taxes paid from the optimal strategy, 92,000 in taxes paid from the less optimal. Let’s take Social Security sooner strategy. This is a good example of a reason that we commonly hear of why you want to take your Social Security earlier, and it’s to protect your asset balances or to preserve the amount of money you have in savings. This quite clearly shows that that may not always be in your best interest. Of course, how much you’ve saved for retirement, your spending level, your age, all of these factors should be considered in the context of an overall retirement plan with respect to your Social Security.
One of the big takeaways here is not to make that Social Security election decision without having the full context, like Paul Harvey used to say. Now for the rest of the story, because if we just looked at Social Security in isolation, and we looked at the potential savings, let’s say it’s $150,000 or $250,000 that you don’t have to pull from your retirement if you take Social Security earlier, if you don’t have the rest of the story, what happens at age 77, 78, 79, and age 80, where you’re pulling far more from your account balances, providing or putting you into a position with less security, not to mention significantly less income from Social Security, well, then, you’re making the decision without all the information.
Reason Number 3
Reason number 3, to take Social Security early. This is not something we actually commonly hear, and it may be something that you’ve never thought of and maybe it doesn’t apply to you or your family situation. Not too long ago, we had a client and we sat down and we were going through these iterations of the Social Security analysis. Whenever someone becomes a new client or whenever someone gets to the point where, hey, we’re thinking about taking Social Security, we start to do the analysis. This gentleman and his wife happened to be new clients and we started to go through the Social Security analysis.
She was about six years older than he. She did not qualify for Social Security based on our own earnings record. She was strictly dependent on the husband to take Social Security so then she could activate spousal benefits. If you don’t have 40 quarters of paying into the Social Security tax system, you don’t qualify for your own Social Security benefit. Because she was older, and the rules say you cannot elect spousal benefits until your spouse actually activates theirs, the husband, which in this case, I have labeled as the worker at full retirement age, his benefit would have been a thousand dollars a month.
I’m rounding out to make this a simple way for you to follow the math, but he is actually age 62 now. Worker age 62, but at full retirement age, which for him would have been age 67, would have received a thousand dollars per month. The spouse was 68, does not qualify for Social Security benefits, so her benefit at full retirement age is zero.
If he turns it on early, so at 62, there’s a 30% reduction. It’s a lifetime reduction in your benefits from Social Security. He receives $700, but because he activates his benefit, she is eligible to turn on spousal benefits, which equals one half of what his full retirement age benefit would be if he had deferred. Even though he does not defer, his benefit at full retirement age was $1,000. She is entitled to half of that because he has now activated his Social Security. The combined benefit here, 700 plus 500 is 1,200 a month, 14,400 a year, going to receive $72,000 over the next five years, which is income that they would not have received if he decided to defer until age 67, which was his full retirement age.
Simple math here, if he did wait until 67, he would turn it on at a thousand, she would then activate it, because she can activate it once he turns his on, so 500 a month for her, $1,500 a month total. It’s only an extra $300 a month above the 1,200 that we got them by implementing this strategy. It’s going to take about 20 years just looking at the simple math for the cumulative income received from Social Security to catch up at this $300 per month extra, compared to the strategy that we first recommended and that they implemented.
This is an instance when one spouse is older than the other and that spouse does not qualify for their own Social Security benefits. It may make sense for the younger spouse that has qualified for Social Security to activate that benefit at 62, then the spouse can turn on their Social Security spousal benefit. Then when you do that math, and then, of course, we need to tie that into a plan, but in this particular instance, every which way we ran it, it made sense for them to implement that strategy.
Reason Number 4
Number four is a very interesting case study, and one of the common reasons we here to that people want to take Social Security is that I don’t feel I have a lot of money saved for retirement, and I need to take Social Security soon, so I don’t have to withdraw as much from my savings. Now here’s where it gets interesting. In the beginning, I said the parameters were $4,000 a month spending, and Social Security was 2,500 per month. That’s 30,000 from Social Security if you annualize it. The spending at 4,000 a month is 48,000.
The difference between Social Security and the spending level is $18,000. If you have $500,000 saved, that’s what we want to look at in this example. The 4% rule says that you should be able to withdraw 4% of the $500,000, which is 20 grand, and that 20 grand should fill that gap, which is 18,000. The difference between how much Social Security will provide you 30,000 a year and how much you want to spend $18,000 a year.
That 4% rule should cover that gap. This is one of the reasons why we’re not a big fan of the 4% rule, because it discounts all of the other factors that go into what makes retirement successful for you. I want to show you here and then go into the ledger. The green is exactly what I just said. Take Social Security early, and then withdraw the rest of the income that you need to keep to meet your spending goals from the portfolio. This makes a lot of sense if you’re in this situation at age 62, but I want to show you where it goes off the rails.
We can visually see here the difference between and why someone would want to take Social Security early, because we have a much higher asset balance. The green line is taking Social Security early. What happens is compared to taking it later, we’re spending down our savings. Then we level off because we have so much money coming from Social Security, we barely need to tap into our savings at all. There’s another concept, I’m going to do a calculation to show you here that I think you should understand to help make this decision if you’re considering something like this. Before I show you that calculation, I want to run through the ledger with you.
Over here, we have the optimized income distribution, tax, and Social Security election strategy. Very clearly, we see we’re deferring Social Security, but we’re spending down the asset level. This would be a very scary situation to be in if you were watching your $500,000 life savings deplete all the way down here to about $100,000 before you turn Social Security on. Once you get a full year of Social Security, it’s 58,000 bucks, which exceeds most of what your spending goal is.
Over here, we take Social Security early, and we see our asset balances stay fairly intact, at least in the beginning years here. Again, similar to the previous case study, because Social Security is so much less than what our inflation adjusted spending goal is, we’re forced to start spending down the portfolio pretty aggressively in our mid-70s to late 70s.
Even at life’s expectancy of age 83, we see a very clear distinction here. One, we run out of money with the take Social Security early strategy. We have far less income from Social Security than the deferred strategy, but what we’re not taking into consideration, I think at age 62, or when we’re considering electing this strategy, is what the actual value of this lifetime income payment is at age 70. I pulled up a time value of money calculator so we can look at the actual value of that lifetime income stream.
The Social Security just coming back here of about $60,000 at age 71, even though we have about $100,000 left, $91,000 of savings, but we’re not oftentimes considering what the actual value of this payment stream is for the next 12 years of our life expectancy. Discounting at a rate of 3%, the present value of that income stream over a 12-year period is actually $600,000. Even though in the optimized Social Security strategy compared to taking it early, we’re down to about $100,000, and we went through this very emotional period where we’re probably feeling uncertain and not sure if we made the right decision.
We have to take it in consideration that this income stream from deferring Social Security, the $60,000 a year increasing is actually worth about $600,000 to you, and it’s actually worth more because in the time value of money calculation that I did, it wasn’t entirely accurate because that was looking at a series of even cash flows when the correct calculation would be to look at a series of uneven cash flows, the present value of a series of uneven cash flows, but because that calculation takes a lot more time to work, you have to manually enter all those uneven cash flows. I just did the simple version. It’s a more conservative and it’s about $600,000.
One of the other thing to note there is technically I would want to go back in, or I should go back in and add in this first year of cash flow, which I did at a 48,000. Really, it’s probably worth somewhere between $700,00 to $750,000 when we were to add back in the first year’s cash flow, as well as the increasing payments from the Social Security cost of living adjustment. It’s a pretty substantial value that higher Social Security check.
For comparison purposes, if we look at the same calculation, and at age 71, we have about $35,000 of Social Security benefits. If we look at the present value of that income stream, 35,000 same variables here, 348,000. Now if we come back, and we add the 348 at 71 to the 341, we get about $700,000. About roughly the same calculation there, but if we look at the decreasing asset balance, if we run that calculation in any subsequent year, it’s going to be a negative net present value.
What the decision to take Social Security early, what it fails to look at is all of the other variables in retirement. This is why making this decision inside of a plan is the most important thing that you can do. We don’t want to just make this Social Security decision by how we feel or what we think is the right thing. We need to be able to look at the math, look at the plan, how these different variables come together.
After we do that, if you still decide that it makes sense to take Social Security early, then go for it. You’ve made the decision with all the information, but as we start to go through this with people and start to show them quantifiably why it may or may not make sense, but also what really impacts people the most is having these conversations and actually feeling the feelings, having the visibility to see, okay, if I make this decision, this is what the future looks like, how would I feel? How does that make me feel now? How would I feel at age 70 or 75 or 77?
Going through that process, you may not come to the moment of clarity right in that instant, but as you go home, think about it, pray on it. You oftentimes come to the decision that’s right for you and your family.
Reason Number 5
The number five most common reason we hear from people of why they want to take Social Security early comes from those that have accumulated a great deal of wealth for retirement. I’m talking 2 million, 6 million, 10 million. They feel that it’s possible that a means-testing system could be put into place. When you’ve accumulated a large sum of wealth, a couple of things happen. One, naturally your income is typically much higher because interests, dividends, or required minimum distributions, if a lot of that wealth that’s inside retirement accounts, forces you into higher income tax brackets.
If that’s the case, and the government says, okay, anyone who makes over $150,000 a year in retirement should have a 25% reduction in Social Security or a 50% reduction. I don’t know that this is going to be the case, but I do know one of the recent studies from, I believe it was the Congressional Budget Office proposed a bunch of solutions to help fix the Social Security shortfall, the budget shortfall.
Is Social Security Going Away?
We do not think that Social Security is going away, but one of the proposed solutions, and this is a very realistic possibility for those people that have accumulated a large sum of wealth, is that a means-tested system could be put into place. If that does come to fruition, it means if you have income over a certain level, then a certain percentage of your Social Security benefits could go away.
Now, I don’t want to alarm anyone, I don’t want to scare anyone. I’m not necessarily predicting this. I’m just taking info from what the government has put out as a possible solution to the Social Security budget shortfall, and helping you understand why it is a common concern that we hear, and forces some people in that situation to want to take Social Security sooner.
Means-testing is not new. We have it in a lot of aspects of the tax code currently. A great example is the net investment income tax. Not too long ago, this tax did not exist, but if you are a married couple that makes over $250,000 a year, there’s an additional 3.8% surtax placed on your investment income.
Same thing with Medicare. Not too long ago, IRMAA did not exist. IRMAA is an acronym. It stands for Income-Related Monthly Adjustment Amount, and it is an excise tax on your Medicare benefits based on the level of income. If you cross over a certain level of income, you have to pay more for Medicare. There are other aspects of the tax code, of course, where if you reach certain levels of income, deductions go away. There are phase-outs. This is not something that’s new, and it is a proposed solution potentially for fixing the Social Security shortfall.
That is a common reason, and that one, it’s really subjective.
The Bottom Line
You’re going to be okay one way or the other if you take Social Security or do not take Social Security, or if it goes away, assuming you don’t spend a ridiculous amount of money based on that wealth that you’ve accumulated.
These are five reasons that we’ve commonly heard of why people want to take Social Security early. Three of them, I think, absolutely can make sense. A couple of them obviously do not, and it’s up for you to gather all the information, look at Social Security, not in isolation, but in the context of an overall plan, and make the best decision for you and your family.
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Disclaimer: This video discusses fixed-income investing and utilizes the 10-year U.S. treasury as a general representative fixed-income investment. Conclusions reached, opinions stated, and downside risks and potential returns presented should not be construed as applying to other types of bonds or fixed-income assets. Other types of fixed-income products carry different levels of risk and return potential and should be evaluated as an element of a diversified portfolio with your specific risk tolerance, investment objectives, and timeline in mind. Nothing in this video is investment advice, an investment recommendation, or an offer to buy or sell any security. Investing involves risk.