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If you’ve spent time planning for retirement, you probably know the basics of Social Security. Most people can begin receiving benefits at age 62, reach full retirement age (FRA) between 66 and 67 depending on year of birth, and can defer benefits until age 70(1).
The longer you wait, the larger your monthly payment will be—according to the Social Security Administration (SSA), delaying beyond FRA can increase your benefits by up to 8% per year (2).
On paper, this sounds like a good deal. But in reality, the decision is more complicated, and for some retirees, the delay could end up costing them money.
That’s why the simple math behind deferred benefits doesn’t always work.
The problem with the “basic math” behind deferring Social Security is that it often ignores longevity risks. While waiting longer does increase your benefits, your total lifetime payout may be lower if you don’t live as long as expected.
For example, if you wait until age 70 to start receiving benefits and die at age 72, you only receive two years of payments. Claiming early—even at a lower rate—can result in a larger total payout over your lifetime.
If you die before age 70, you actually get nothing from the system you spent money on for decades.
Additionally, the program’s fate has been questioned. If underfunded, the program could exhaust its trust fund by 2032, which would result in a 23% reduction in benefits for retirees and people with disabilities (3). With that in mind, many Americans approaching retirement are doing some complicated calculations about the amount they might receive and their life expectancy.
To be fair, lifespan estimates are inherently uncertain. According to the Peterson-KFF Health System Tracker, average life expectancy in the United States is approximately 78.4 years, but individual results vary widely (4). Many live into their 80s and 90s, while others do not reach the average life expectancy.
To help cope with this uncertainty, many financial advisors use “break-even age” analysis. This calculation estimates the age at which the cumulative benefit from delaying Social Security receipt exceeds the cumulative benefit from early withdrawal.
For example, someone receiving $2,000 per month in full retirement at age 67 would need to live to be 78 years and 8 months older to come ahead compared to when they collected their pension at age 62. If they wait until age 70, the break-even age will rise to approximately 80 years and 5 months(5).
However, even this analysis has limitations. It typically does not take into account the time value of money, or the opportunity cost of capturing and investing early gains. Trying to calculate your break-even age also assumes you have adequate reserves—about 4 in 10 Americans don’t have such a nest egg, according to a Gallup analysis (6).
Read more: Nearing retirement but no savings? Don’t panic, you’re not alone. Here are 6 easy ways you can catch up (and fast)
If you retire at age 62 but delay taking Social Security until age 67, you may have to rely on withdrawals from savings or a tax-advantaged account (such as a 401(k)) to pay for living expenses. By doing so, you are giving up the potential investment returns that these funds could have earned had they not been affected.
This trade-off is called opportunity cost and is an important factor to consider in retirement planning.
When you factor opportunity costs into a break-even analysis, the age at which it becomes beneficial to delay benefits can be pushed back significantly.
For example, someone who qualifies for $2,000 per month in full retirement at age 67 would need to live to approximately 88 years and 8 months to reach break-even age, assuming an annual return on investments of 5%.
If the expected annual return is 8%, the break-even point may not be reached over a typical lifetime. In other words, in this case, taking benefits early while keeping retirement savings invested may produce better financial results.
However, once you realize your break-even point, there are ways to reduce your opportunity cost.
If you want to delay your Social Security payments, you’ll want to build up a sizable emergency fund to avoid taking money out of your investments for as long as possible. Of course, with so much money saved, you need to make sure it keeps pace with inflation.
A high-yield account like the Wealthfront Cash Account can be a great place to grow your emergency fund because it offers competitive interest rates and easy access to cash when you need it.
The Wealthfront Cash Account offers a base variable APR of 3.30%, but Moneywise readers can get a 0.65% boost for the first three months, for a total APR of 3.95%. That’s more than 10 times the national deposit savings rate, according to a January report from the Federal Deposit Insurance Corporation.
With no minimum balance or account fees, 24/7 withdrawals, and free domestic wire transfers, your funds are always available. In addition, the FDIC insures Wealthfront cash account balances up to $8 million through program banks.
Because the basic math behind Social Security decisions often ignores key variables, and estimated factors such as investment returns and longevity are inherently uncertain, it may be wise to work with a qualified financial advisor.
A professional planner can help you consider other factors such as inflation, estate planning, health care costs and annual spending needs.
Through Vanguard, you have access to a personal advisor who can help evaluate your performance so far and ensure you have the right portfolio to achieve your goals on time.
Vanguard’s Hybrid Advisory System combines the advice of professional advisors with automated portfolio management to ensure your investments achieve your financial goals.
All you have to do is fill out a short questionnaire about your financial goals, and a Vanguard advisor will help you create a customized plan and stick to it.
What’s the bottom line? Oversimplifying your retirement strategy can be costly. A more comprehensive, personalized approach can help you make smarter decisions and improve your long-term financial outcomes.
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