This frequently used Social Security strategy could cost you $182,000
Americans are fascinated with getting the most out of Social Security, but many retirees are making a strategic mistake that can cost them tens of thousands of dollars in lifetime benefits, according to new research from economists at Boston University and the Federal Reserve Bank of Atlanta. The analysis examines the issue of the optimal age to claim Social Security in order to maximize retirees’ lifetime discretionary income, or money after taxes, living expenses, and other essential costs. The Social Security Administration pays a worker’s full benefits at what it calls “full retirement age,” which ranges from 66 to 67 years old, depending on your birth year.
But people can also claim Social Security as soon as they turn 62, with the tradeoff of a roughly 30% reduction in their monthly checks. On the flip side, if workers wait to take Social Security until they turn 70, they get a 32% boost in their payments in exchange for holding off. The reality, however, is that only 6% of U.S. workers wait until they turn 70 to claim Social Security, even though the vast majority would be better off waiting until then to trigger their retirement benefits, the researchers found.
There’s a very real price tag to claiming Social Security too early, as the typical worker is leaving about $182,000 in lifetime discretionary income on the table by claiming before they turn 70, the report noted — income that most Americans could sorely use given that many haven’t saved enough to carry them through old age. Almost half of Americans claim Social Security before they hit full retirement age, and about one-quarter claim at age 62, according to data from the Social Security Administration. Americans “have to change their thinking,” said Laurence J. Kotlikoff, one of the study’s co-authors and an economics professor at Boston University.
Some people decide to claim Social Security early based on the average life expectancy for 65-year-olds, which is 83 years for men and 85 for women. But a better rule of thumb is to consider what Kotlikoff and his co-authors call “the worst outcome, financially speaking” — living until one’s maximum age of life, which could be in the upper 90s or even 100 years old. The bottom line is that “we can’t count on dying on time,” said Kotlikoff. Instead, Americans should use financial strategies that can help them delay when they claim Social Security, which will boost their lifetime discretionary income.
However, claiming at 62 could give a retiree an extra eight years of Social Security income that they could spend or save compared with waiting until age 70 — a tempting offer for someone who believes that money could be put to good use at that moment, such as toward living expenses or savings. And people who worry they might not have as many years ahead of them as their compatriots might also be tempted to claim early to enjoy the benefit while they can.
Take an unmarried worker who is currently 60 years old and earns $80,000 a year. She’ll be able to claim her full benefit of $35,337 per year when she turns 66. She could also claim when she turns 62, but with a reduced annual payout of $26,502. Nevertheless, she’ll enjoy eight additional years of those benefits, or an extra $212,016 over that time. To be sure, she’ll get more money annually if she waits until she turns 70, with her Social Security payments bumping up to $46,947 per year. That represents 77% more income than if she claims her benefit at 62. But she’ll need to collect for more than 10 years at that higher payment level until she breaks even with what she would have received via an extra eight years of benefits from age 62 to 70.
Almost half of Americans over 55 lack any retirement savings, which means those workers will be more reliant on Social Security in their old age and may be tempted to claim early in order to have a steady stream of income as soon as they turn 62. But Kotlikoff said people who remain physically active when they turn 62 should stay in the labor market rather than claim Social Security because by maximizing their benefits, they’ll be better off in the long run. In a recent analysis, it was revealed that the only people for whom it might make sense to claim Social Security benefits early are those with a terminal disease or who are disabled. This was emphasized by economist Laurence Kotlikoff, who pointed out that most people who are retiring early are able-bodied and should consider finding a job in the current labor market instead of claiming benefits early. Kotlikoff also highlighted the absurdity of spending more time in retirement than in the workforce.
For individuals looking to delay claiming Social Security benefits until full retirement age or later, there are several strategies that can be employed. One option is to draw down retirement savings from a 401(k) or other accounts before tapping into Social Security. Additionally, cost-saving measures such as moving in with relatives or taking a loan from family members can help bridge the gap until reaching age 70.
While delaying Social Security benefits may result in a temporary reduction in cash flow for individuals in their early to mid-60s, the impact on household spending may not be as significant as feared. Kotlikoff’s analysis found that waiting to claim Social Security only reduced median household spending by 7%, indicating that many people have additional resources beyond Social Security to rely on.
However, Kotlikoff also stressed the importance of saving more for retirement. A recent study by Northwestern Mutual revealed that Americans believe they will need $1.25 million in savings to enjoy a comfortable retirement, yet the average retirement account in the U.S. holds less than $87,000. This disparity highlights the need for individuals to take a more proactive approach to saving for their future, rather than relying solely on government and employer-provided benefits.
In conclusion, while claiming Social Security benefits early may be necessary for individuals facing terminal illness or disability, most retirees should consider working longer and implementing other savings strategies to delay claiming benefits. By saving more and planning ahead, individuals can better secure their financial future in retirement.
