When to take retirement is a top concern among pre-retirees. Claiming social security too early could risk retirees having less money in their final years. On the other hand, delaying claiming social security could result in retirees leaving money on the table in case of an early demise. Although both options have their pros and cons, retirement researchers have long been recommending delaying Social Security benefits to as close to age 70 as possible.
If you are also nearing retirement age and are planning to delay Social Security, then you need to understand why delaying Social Security is good for you.
The best way to understand the importance of delaying Social Security is to understand the significance of “real” interest rates. It is the rate you earn on your investments after adjusting for inflation.
In recent years, inflation, as well as interest rates, have gone up significantly, and due to this, real interest rates have lagged behind the actual interest rates.
Social Security benefits offer protection against inflation, as the benefits are adjusted yearly for inflation. The 2023 Social Security benefits, for instance, got an 8.7% increase as protection against inflation. Such adjustments compensate for inflation and push the real interest rate ahead of the actual interest rate.
Although an increase in the real interest rate weakens the argument in favor of delaying Social Security, experts believe the current rise in the real interest rate isn’t large enough for most people, including an unmarried person and for higher earners for married couples.
Apart from the real interest rate, you should also understand the protection that Social Security offers against the risk of living a long time.
Delaying claiming Social Security helps to reduce the longevity risk. It means delaying the benefits reduces the risk (“fear” might be a more apt word) of outliving your money.
Life expectancy is much higher today, so, the longer you delay, the more you will have when you need it the most. In fact, experts say that the chances of benefitting from delaying Social Security are more than 50% for reasonably healthy individuals.
New research, backed by numbers, also supports delaying Social Security benefits.
A new paper in the Journal of Financial Planning claims that delaying Social Security benefits to age 70 (rather than 62) raises the monthly benefits by 77% in terms of inflation-adjusted returns. The research paper uses the actuarial data (designed in 1983) that is used to determine Social Security benefits to prove its findings.
The Social Security system uses life expectancy data to set the benefits at levels so that the system pays more or less the same lifetime benefits at all levels when people live to average life expectancy. However, the average life expectancy now is much more than in 1983, i.e., when the benefit levels were set.
It means that more than half of an age group is now likely to live beyond average life expectancy. In other words, more than half the age group will get higher lifetime benefits if they delay claiming the benefits.
Also, interest rates were much higher in 1983 than they are now. This means you receive less return on investments than 40 years ago. Thus, it is logical to use other assets to pay for expenses and delay Social Security so that you can enjoy higher benefits later.
On the other hand, the strategy to claim Social Security early will truly benefit if the investment returns are enough to offset the automatic increase in benefits from delaying Social Security. According to the research, the annual increase is about 8% per year for delaying benefits between full retirement age and 70.
Even if your investment generates a return more than the automatic increase, there is no guarantee that higher returns will continue in the future as well. The increases in Social Security benefits, on the other hand, are guaranteed.
Social Security benefits are adjusted for inflation each year. So, if you are taking Social Security benefits earlier, then the investment returns through retirement funds must be higher than inflation indexing as well.
So, the strategy to claim benefits early could push retirees and near-retirees to take on more investment risk than they normally would.
Tax diversification is another benefit of delaying Social Security benefits. Though Social Security becomes taxable once the retiree’s total income exceeds the set limit, even then not 100% of the benefit is taxed.
So, if you delay Social Security and use pretax retirement accounts during that period, it will help to bring down the future RMDs (required minimum distributions), which are 100% taxable.
Delaying the benefits is extremely beneficial for the higher-earning spouse. A married couple receives two Social Security benefits if both are alive, but one benefit ends after the death of one spouse. Usually, the surviving spouse continues to receive the higher of the two benefits. Thus, the couple would want the remaining benefit to be as high as possible, irrespective of which spouse survives.
Though there is no denying that taking benefits early makes sense for some people, even then, the highest lifetime payments in many cases come by delaying benefits. So, it would be best if you took your time in deciding whether or not to delay your Social Security as it is a significant decision in your life.
Making the decision, however, could get easier if you know that deciding to delay Social Security is not a one-time decision. Once you are eligible to claim the benefits, you can claim it at any time. So, deciding to delay is more of a semiannual decision than a once-in-a-lifetime opportunity.
In fact, you can even claim up to six months’ retroactive benefits in a lump sum if you exceed your full retirement age. This could alleviate a primary concern of people delaying Social Security, and that concern is missing out on benefits if circumstances reveal the possibility of a shorter-than-expected lifespan.