When we talk about optimizing social security, most people try to maximize their total return. However, unless you have so much money that you will never need the social security money, looking at social security in terms of your lifestyle is much more important. But, before we get to that, let’s go over the numbers just so we know what we are working with.
How Social Security is Calculated
Your social security benefit is calculated based on your age when you start claiming benefits and your highest 35 years of adjusted earnings. Your earnings each year are adjusted based on an index factor that looks at the growth of the average wage in America. The full social security retirement age is currently 66 but is gradually rising to 67. At this age, you are able to collect the full benefit which is calculated by averaging your highest 35 adjusted earnings years. From that number, you will get 90% of the first $895, 35% of earnings between $895 and $5,397, and 15% of earnings above $5,397. For example, I listed the benefit for 3 different average monthly earnings.
|$500||$500 * 0.9 =||$450|
|$3,500||$895 * 0.9 + ($3,500 – $895) * 0.35 =||$1,639.10*|
|$6,000||$895 * 0.9 + ($5,397 – $895) * 0.35 + ($6,000 – $5,397) * 0.15 =||$2,336.60*|
*round to nearest dime
The next factor to consider is the age at which you claim. Each year you wait past your normal retirement age, you will get an 8% increase in your monthly benefit. If we use the $6,000 earnings case with a benefit of $2,336.60 we get the following.
What Age To File – The Numbers
The optimal age to start collecting depends on the investment returns you expect to get and your life expectancy. Following is a spreadsheet comparing the total returns of different benefit claiming ages. This spreadsheet assumes just under 5.7% returns which were calculated by weighting reasonable expected returns of the assets to my parents target asset allocation of 65% equities 35% bonds. Higher returns will increase the age where waiting to file pays off while lower returns will reduce the age that waiting breaks even.
The current life expectancy for people that are 62 years old is 84 years old. As you can see given these assumptions claiming as early as possible will yield the highest total returns for the average person. This is contrary to the typical advice of waiting as long as possible. You will need to live to age 93 in order for waiting until age 70 to start benefits to be the best option. This is 9 years past the average lifespan at age 62.
What Age To File – Lifestyle
Claiming social security benefits is one instance where it is important to consider more than the numbers. To do this, I will break down 3 different circumstances. You will have different considerations if you need the money to survive now, if your finances are indestructible, or if your finances are fragile to disasters.
Needs Money To Survive Now
If you are unable to get enough money to survive without claiming your social security benefit, you do not have a choice. No other considerations are necessary, you will need to claim your benefit now.
You are so wealthy that even the great depression would not have affected your lifestyle. In this case, you will want to go with the numbers to maximize your total return. If you are healthy and think you will live past 93 you will wait until 70 before collecting. If you think you can get better investment returns or that you will die earlier, you will want to collect as soon as possible.
This is the group that is most interesting because their best option goes against the numbers. The reason is that if you are in this group, you have enough money to support your lifestyle now, but it is fragile to economic turmoil that can do significant damage to your nest egg. You have the option to claim right away and enjoy a minor increase marginal utility. Maybe you buy a slightly fancier car, or live in a slightly bigger house, but nothing that will dramatically improve your happiness. However, if your nest egg is destroyed in a depression style crash, you will need to drastically cut your lifestyle and may even jeopardize retirement at an age you are unlikely to want to or be capable of working.
Now if instead, you wait to claim your benefit, you still get to keep your current lifestyle without those slightly nicer comforts, but if an economic disaster occurs, you will be able to claim a much higher monthly benefit that supports a much higher lifestyle than your twin that claimed early. The downturn will affect you less both in absolute and relative terms. The reason waiting is better isn’t because you will make more money, it is because it mitigates your downside risk which has a much bigger impact on your life than the potential upside of claiming early.
What are your plans for claiming social security? Why?