Most personal finance experts suggest that you wait to claim Social Security benefits as long as possible because each year you delay (until you turn 70), the larger your monthly benefit gets. But some investors may see an opportunity in taking Social Security early: Doing so would allow them to draw down less on their own assets, leaving more money invested in their nest eggs where it can keep growing.
It's certainly possible to come out ahead by claiming Social Security early when factoring in your investment returns. But for most retirees, it's probably not worth the risk.
Image source: Getty Images.
A mathematical analysis
Consider this example: You're an average earner whose full retirement age benefit would be $1,625 per month, and you retire at 62. By claiming as soon as you eligible to do so, they cut their monthly benefit by 30% to $1,138.
Instead of using that income to pay bills or go on vacations, you invest it in a special account. Every month, you buy $1,138 worth of stocks, bonds, and whatever other assets you think will provide the best performance over the next five or eight years. Ideally, this will result in a bonus portfolio you can draw upon throughout the rest of your retirement that will more than make up for the bigger payments you missed by not waiting to take Social Security.
Assuming an average 2% annual cost of living adjustment, you could've claimed a benefit of $1,794 per month had you waited until 67 to do so. That compares to the $1,256 per month you'll actually be collecting by then, as your $1,138 monthly payment will also have gotten those 2% COLAs over time. Based on a 5.3% safe withdrawal rate for 20 years, the portfolio built using those early Social Security checks will need to have grown in value to $121,866 in order to fund the $538 monthly difference. To accomplish that would take a steady return of just under 20.7%.
Waiting to claim benefits until you turned 70 would've resulted in Social Security checks that were $1,028 per month larger. In order to safely provide that much cash flow, the portfolio you funded using those Social Security checks would have needed to climb to $232,784 over the intervening eight years. That would require a steady annual return of nearly 16.2%.
Typical expected returns don't come close to generating a big enough portfolio to safely replace delayed Social Security. Chart source: Author.
Those are uncommon results. Only about one in ten historical rolling eight-year periods have produced average annualized returns above 16.2%.
A case study
I can't imagine anyone actually investing their Social Security income in a separate account, though. Instead, they're more likely to use the income from the program to offset how much they have to withdraw from their existing retirement portfolio.
Imagine you retire at 62 with a $1 million retirement portfolio. You can collect your $1,625 Social Security check at full retirement age in five years, or you can start to take your benefit immediately and collect $1,138 per month. You've budgeted $53,650 annually for spending and taxes. (Conveniently, that works out to 4% of $1 million, plus your 12 monthly Social Security checks.)
Again, we'll assume a 2% cost of living adjustment, which is the inflation metric used to increase their annual withdrawals as well. Each year, you withdraw enough from their retirement portfolio to make up for the difference between your budget and your income from Social Security. So, if you delayed Social Security, you'd have to withdraw the full $53,650 from their portfolio in that first year, but you could reduce that to just $40,000 if you claimed early.
At age 92 -- 30 years into retirement -- in order for you to have the same portfolio value as you would have if you'd delayed claiming until 70, their retirement portfolio would need to have produced consistent annualized returns of 7.78%.
That might sound achievable. But most retirees' portfolios are designed to preserve capital, and therefore have more conservative asset allocations, which lead to less robust returns. What's more, a poor sequence of annual returns early in their retirement will harm the early claimer more, requiring a higher average return for them to come out ahead.
The table below shows the portfolio value at age 92 based on various portfolio returns. It also shows how a poor sequence of returns to start retirement can effect the final portfolio values.
| Claim at 62 | Claim at 67 | Claim at 70 | |
|---|---|---|---|
| 5% steady returns | $771,409 | $904,391 | $968,079 |
| 7% steady returns | $2,754,432 | $2,819,502 | $2,832,901 |
| 7.78% steady returns | $3,973,320 | $3,990,975 | $3,973,321 |
| 7.78% poor sequence* | $4,122,064 | $4,483,862 | $4,418,309 |
| 7% poor sequence** | $809,616 | $1,088,240 | $1,165,032 |
*A sequence where the portfolio returns 2% for 10 years, 10.4% for the next 10 years, and 18.8% for the next 10 years, for a compound average growth rate of 7.78%.
**A sequence where the portfolio returns 2% for 10 years, 7.08% for the next 10 years, and 12.16% for the next 10 years, for a compound average growth rate of 7%.
Table source: author. Calculations by author.
Indeed, delaying the day you file for Social Security provides good protection against a weak period for your investments early in your retirement despite the higher portfolio withdrawals. That's because there's a planned decrease in withdrawals five to eight years into retirement.
Other real-life considerations
The above examples ignore several real-life considerations.
One big consideration for any retiree is taxes. Taking Social Security later gives people more time to optimize their tax positions before that new stream of income enters the equation. Retirees need to be mindful of things like required minimum distributions and capital gains, and a few years without any additional income can provide opportunities to reduce those later on.
The other consideration is that retirees should err on the conservative side. What's more important to you: maximizing your net worth at age 92, or ensuring you don't run out of money before then? Social Security offers a great return with very little risk for those who wait to collect it. While it's possible (albeit unlikely, in my opinion) for you to outperform that with a well-designed and lucky investment strategy, why take the risk? A more appropriate risk would be to adjust your asset allocation to include the present value of your future Social Security benefit.
If you want to claim Social Security early just to invest it, you'd better have high confidence that you'll be able to produce some very good returns. Even if you need to withdraw more than 4% a year from your retirement portfolio to make ends meet during those early years, you'll probably be better off doing that, and then reducing your annual withdrawals after you claim Social Security at 70.
