Collecting Social Security: Part II

Dear Relaxing Retirement Member,

Let’s continue our discussion from last week about our new Relaxing Retirement members, Al and Carla (names changed to protect their identity).

I’d like to expand on the second major factor they need to consider when deciding if they should begin collecting social security now while they’re 64 years of age vs. waiting until they’re 66 and have reached social security’s definition of “Full Retirement Age” (FRA).

To refresh your memory, Al wants to continue working after he retires from his career job.

He and Carla are wondering if it’s worth it to begin collecting social security right now vs. waiting until he’s age 66.

I told Al and Carla that there are 2 major factors to consider. We discussed the first factor last week, which was the “earnings limit” that social security places on you.

The second factor is the “math”. In other words, is it worth it to wait until Al and Carla turn 66 to begin collecting, or are they better off starting right now at age 64?

The “Math” Behind the Decision

Before examining the other factors, let’s discuss the math. For the sake of the example I’ll use here today, let’s assume for a moment that Al and Carla are actually age 62 (not 64) as that is the age at which Americans may now begin receiving social security retirement benefits.

Since Al is the one considering working part-time after he retires from his full-time job, he’s the one we are going to focus on today. Carla’s decision is actually different and we’re going to expand on her options in a little while.

Al’s social security benefits statement shows that his monthly benefit at age 66 will be $2,000 per month. And, if he begins collecting at age 62, his benefit will be $1,500 per month (75% of his age 66 benefit).

If Al starts collecting now, he’s going to take a 25% pay cut! That doesn’t sound too great, does it?

However, he really needs to take a look at the math for a moment:

  • Monthly Benefit at age 66 (if he waits) $2,000

  • Monthly Benefit at age 62 (today) $1,500

If he takes his benefit today, Al is going to receive $500 less per month.

What That Really Means

As I pointed out to Al and Carla, if they decide to wait until Al reaches age 66, what they’re really saying is that it’s worth it to wait 4 years (or 48 months) to get the extra $500 in the 49th month and beyond.

However, an intelligent question to ask is “what are they giving up by waiting”?

What they’re giving up is 48 months (4 years from age 62 to age 66) of social security benefits. That’s $72,000!

Not an insignificant number.

The “Break Even” Age

In order to recoup that $72,000 that they would give up by waiting until age 66, Al would have to live another 144 months after age 66, or 12 years, at which time he’d be 78 years old. ($72,000 divided by the incremental increase of $500 at age 66 = 144 months)

So, in order to break even, Al and Carla would have to live another 16 years (4 years from age 62 to 66 + 12 years = Age 78).

And, this doesn’t take into consideration 3 other factors:

  1. Al and Carla will likely receive a cost of living increase each year on their social security benefits, so their benefits will begin increasing after their first year of collecting.

  2. If Al and Carla begin collecting at age 62, they could invest their monthly check and potentially earn even more.

  3. Finally, and this is the most important factor in maintaining their lifestyle sustaining income over the rest of their lives, if they don’t draw from social security right now, they must draw income from some other source, i.e. their investments. Delaying social security reduces their inflation fighting investments more rapidly.

And, if the majority of their investments are in IRAs or other retirement plans, it may potentially reduce them even faster because they have to pay income taxes on 100% of what they withdraw vs. a maximum of 85% of their social security income.

Other Factors For Al and Carla To Consider

While Al and Carla’s example should give you a good guideline to use, here are some other factors which may affect your own unique situation:

  1. Life Expectancy: Al and Carla are both in good health and have no overriding problems.

The reason why this is a factor in their decision is that if they have health issues that are predicted to shorten their life expectancy, clearly this should lead them to collect benefits as early as they can get them.

As it was in Al and Carla’s case, however, if everyone in your family has lived well into their 90s, this may pull you in the opposite direction.

  1. Severance: If you’re collecting severance pay from the employer you’re retiring from, this may alter your desire to begin collecting right now because of the taxes you’ll pay on your social security benefits while you’re also receiving large severance pay.

  2. Deferred Compensation: This same principle applies to deferred compensation. Let’s say that for the 5 years prior to your retirement, you’ve contributed to an executive ‘deferred compensation’ plan. If the plan calls for you to receive a payout immediately upon retiring, as many of our members do, this may have adverse tax consequences on your social security benefits.

  3. Other” Income: If you have other “locked in place” income, you have to weigh the after-tax benefits of collecting social security benefits early.

This dovetails into a major principle that I recommend, and that is to never make any decisions concerning benefits or investments without also simultaneously considering the tax consequences.

This is a monumental mistake that I see in the overwhelming majority of situations.

As you can see, there are several factors that went into Al and Carla’s decision. Hopefully, their example provided a good line of questions for you to answer in your own unique set of circumstances.

Next week, I’m going to delve into the questions Carla had about collecting her social security benefits.

Surprising to many, benefits collected by working and non-working spouses vary greatly if you don’t know the rules.

I look forward to speaking with you, and clarifying those rules next week.

Committed to Your Relaxing Retirement,

Jack Phelps

The Retirement Coach
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(The content of this letter does not constitute a tax opinion. Always consult with a competent tax professional service provider for advice on tax matters specific to your situation.)