You'll Get Social Security Wrong Unless You Do This

The issue that gets the most attention with Social Security is when the best time is to claim your monthly benefit checks. Some believe that claiming as soon as you're allowed to -- age 62 for regular retirement benefits -- is the only smart decision, despite the negative impact that it'll have on the size of your payment. Others advocate waiting as long as possible to start taking Social Security, as you'll get bigger payments.

The Social Security program itself argues that it doesn't really matter when you start taking your benefits. The program's actuaries have defined rules for boosting or cutting the size of checks based on when you claim, with the intent of having all those choices work out roughly the same for someone who lives to a typical life expectancy. Many Social Security analysts confirm this by looking at when people who claim later will catch up with those who claim earlier, as the decisions break even compared to each other at ages that correspond fairly well to current life expectancy tables.

However, there's one element that breakeven analysis almost always neglects to consider. By looking only at the number of dollars you get over the course of your lifetime, breakeven analysis ignores that people value money received earlier more than they value money they get later. That explains a lot of why so many people claim Social Security at their first opportunity, doing so intuitively without even running the numbers.

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What a typical breakeven analysis looks like

The advantage of running a simple breakeven analysis is that it's easy for someone to understand. Consider as an example someone born in 1957 who's turning 62 in late 2019 and is thinking about when to collect benefits. The full retirement age for that person will be 66 1/2, which is the starting point for determining how big a monthly check the retiree will get.

Using the Social Security benefit formula, someone whose full retirement age is 66 1/2 but who claims at age 62 will suffer a reduction of 27 1/2% compared to what they'd ordinarily get. On the other hand, with delayed retirement benefits adding 8% per year to the full retirement age payout, that person would get a 28% increase to their monthly checks. Here's what that might look like for someone whose work history would ordinarily warrant a $1,400 monthly payout at full retirement age.

Chart by author.

Claiming earlier means getting smaller checks, but you'll also get more of them. Specifically, the person claiming at 62 will get 54 extra monthly checks before the person claiming at 66 1/2 gets a penny. That amounts to $54,810. Yet at age 66 1/2, the later claimer will start getting an extra $385 per month. If you take the $54,810 and divide it by $385 per month, you'll see that the later claimer catches up and breaks even after 142 months. That's just under 12 years, making the breakeven date roughly age 78.

The graph below shows the breakeven analysis for claiming at any of those three ages. Typically, those who claim at 70 will break even sometime in their early 80s, which is slightly later than the age 66 1/2 breakeven date.

Graph by author.

Incorporating the value of having money sooner

One of the first things you learn about economics is that money you get sooner is worth more than money you get later. This principle is called the time value of money, and it recognizes that if you get money sooner than you need it, you can generally invest it at a positive return until the time comes to spend it. Conversely, if you need it sooner than you'll get it, then you'll have to pay interest on a loan to get money to spend now.

Breakeven analysis typically pays no attention to the time value of money. It assumes that as long as the total amount of money you receive eventually catches up, it doesn't matter that you got it later.

Yet if you put even a modest return assumption on the money you receive from Social Security, the analysis shifts dramatically. As you can see below, the ages at which one breaks even get moved far into the future.

Graph by author. Assumes 5% return rate in calculating time value of money.

For instance, if you file at 66 1/2, it takes until age 88 before you'll break even compared to age 62. Breakeven dates for filing at 70 are even later, in one's early 90s. Moreover, if you boost the return assumption, you'll sometimes see scenarios in which later filers never catch up to early filers.

Understanding early filing

In this light, it's a lot easier to understand why so many people file for Social Security early. Many people simply need the money early and don't have access to credit to borrow it. Yet even for those who could afford to wait, the value of having that money sooner is more compelling than most analysts give credit.