Welcome back to Financial Literacy Month. Most readers of this column, I know, are saving for retirement but aren’t at retirement age yet.
So every once in a while, I like to do a “call your Mom” column. People on the verge of retirement or newly retired are called upon to make all sorts of major financial decisions that will have a huge impact on the rest of their lives.
One of the most important decisions is when to claim Social Security, and too many people make the wrong choice and end up saddled with unnecessary money worries and simply less to spend in retirement.
Social Security is very complicated—no surprise, given that it’s a venerable government program.
When it’s time for you—or your parents—to choose when and how to file for and claim benefits, consider enlisting the help of a fee-only financial planner experienced with Social Security. You can find one through the National Association of Personal Financial Advisors.
But here’s a brief overview; the basic principle is surprisingly simple, and it’s also easy to see why people do it wrong.
The waiting is the hardest part
The basic principle of claiming Social Security is this: A single person, or the higher earner in a married couple, should wait until age 70 to start receiving benefits.
That doesn’t mean waiting until 70 to retire. It means spending down your retirement savings from the day you retire until age 70, and then supplementing your savings with Social Security.
Why? Because the longer you wait to take Social Security (up to age 70), the bigger the monthly payment (it goes up 8% per year after your official “full retirement age”, plus inflation).
The payments last for the rest of your life—or, in the case of a married couple, for the rest of both of their lives. And the payments are indexed to inflation.
When you spend down your portfolio and wait to take Social Security, you’re essentially converting part of your portfolio into a guaranteed annuity better than you can buy from any insurance company.
Your payment is unaffected by market performance, and you can’t outlive it. “[T]he true value of delaying Social Security is a triple-benefit of hedging longevity, poor returns, and high inflation,” wrote financial planner Michael Kitces on his Nerd’s Eye View blog last year.
And if the idea of a Social Security check brings to mind an impoverished elderly person just scraping by, think again: a couple who both worked long careers at decent salaries could easily end up collecting over $60,000/year in Social Security payments if they claim at 70—and the money isn’t even fully taxable.
Why not take the money and run?
Folks who’ve been through the Social Security process will note that I haven’t said anything about spousal benefits.
For a couple with one working spouse or where one spouse earned much more over their career than another, the higher earning should “file and suspend” at full retirement age so their spouse can begin collecting a spousal benefit.
And there are other complicated filing strategies that a financial planner can help you untangle. I also recommend Jim Blankenship’s detailed book Social Security: An Owner’s Manual.
Yet too many retirees don’t untangle anything: they file at 62, even though the system penalizes you for taking Social Security before your official retirement age.
The number one reason people do this, unfortunately, is because they have little or no retirement savings.
“Imagine the person age 62 and retired due to a layoff, who has no savings whatsoever,” says Mike Piper, author of Social Security Made Simple. “That person obviously has to claim at 62.”
But nearly half of all Social Security recipients claim their benefit at age 62, according to research by Boston College, and not all of them are impoverished. Another reason people give for claiming early is that they want to get in ASAP, before the program is gutted by Congress or runs out of money.
I understand the sentiment, but any cuts to Social Security are likely to fall most heavily on the wealthiest recipients or affect all beneficiaries proportionally.
Claiming early to avoid a hypothetical cut that would disproportionately affect people who file later is a gamble– on a political long shot– that will affect the rest of your life,.
Finally, one possible although unfortunate reason you may need to claim Social Security early is if you have good reason to believe that your remaining life will be short. In that case, sure, get it while it’s hot.
I’m writing about this seemingly arcane and definitely boring topic because I’ve seen people in my family make this mistake and then worry about outliving their money, for no good reason.
In some cases, I’ve been able to help them fix the mistake, but the Social Security Administration changed its rules a couple of years ago to make it harder to undo claiming decisions: in general, after 12 months you’re stuck with what you’ve got.
Given that this is Financial Literacy Month, however, I figured it was time to open the Social Security box and look at some of the rusty gears. Go ahead. Print this column and send it to Mom.
Disclosure: Michael Kitces contributed to a Kickstarter campaign held by the writer.
Matthew Amster-Burton is a personal finance columnist at Mint.com. Find him on Twitter @Mint_Mamster. His new book, Pretty Good Number One: An American Family Eats Tokyo, is now available.