When Should You Take Social Security?

Rande Spiegelman
CPA, CFP®, Vice President of Financial Planning, Schwab Center for Financial Research

March 14, 2012

Brace yourselves—the Baby Boomers are retiring! The first members of this massive generation's leading edge applied for early Social Security benefits (over the Internet, no less) in the fall of 2007, as soon as they reached 62. But is opting for early benefits the wisest choice? Should that first Baby Boomer have waited until now, or even later, to start collecting? Over the next 15 years or so, millions more Boomers will decide when to file for benefits.

When it comes to Social Security, you've got three alternatives:

• Take it early
• Wait until your normal retirement age
• Wait even longer

The normal age for receiving Social Security retirement benefits is a moving target (see table below). You can still elect to take benefits early at age 62, or wait as late as age 70. Given the range of choices, as your 62nd birthday approaches, you'll likely be thinking about more than just how all those candles are going to fit on the cake.

Before you consider whether it makes sense to take Social Security benefits earlier or later, let's take a look at some of the rules.

Normal retirement age (abbreviated as NRA, but sometimes called full retirement age) is when you're eligible to receive full Social Security benefits. The normal retirement age used to be 65 for everyone.

However, under current law, 2002 was the last year anyone age 65 could receive full benefits. If you were born in 1938 or later, your normal retirement age is some point after age 65—all the way up to age 67 for those born after 1959.

If you retire sometime between your normal retirement age and age 70, you typically get a credit. For example, say you were born in 1944. Your normal retirement age is 66, but you intend to take your benefits at age 68.

By waiting the extra two years, you get a credit of 8% per year, which means your benefit is 16% higher than the amount you would have received at age 66.

If you want to skip the math (and who could blame you?), check out When Will You Break Even? below, which shows the effect of early or delayed retirement on estimated benefits.

You can also refer to your annual Social Security statement, which lists your projected benefits at age 62, normal retirement age, and age 70. If you need a copy of your annual statement, you can request one from the Social Security Administration (SSA).

Taking the money early might seem attractive, but it means settling for a lower monthly payment for the rest of your life. Consider the following factors as you decide when to take the money.

1. Your cash needs. If you're contemplating early retirement and you have sufficient resources (adequate investments, a traditional pension, other sources of income, etc.), you can be flexible about when you take Social Security benefits. However, if you can't make ends meet without electing for an early, reduced benefit, you may want to consider postponing retirement for a few years until you reach your normal retirement age, or even longer.

2. Your life expectancy and break-even age. Taking Social Security early reduces your benefits, but it also means you'll receive monthly checks for a longer time. Taking Social Security later results in fewer checks during your lifetime, but the credit for waiting means each check will be larger.

At what age will you break even and begin to come out ahead if you delay Social Security? The break-even age depends on the amount of your benefits and the assumptions you use to account for taxes and the opportunity cost of waiting (investment return you could have made, inflation, etc.).

The SSA has several handy calculators you can use to estimate your own benefits. For example, if you're a top wage earner turning 62 this year and your monthly benefits (in today's dollars) at ages 62 and one month, 66 and 70 are $1,879, $2,533 and $3,384, respectively, then your break-even ages are as follows:

• 62 (early) vs. 66 (NRA): Break-even age is between 76 and 77.
• 62 (early) vs. 70 (late): Break-even age is between 78 and 79.
• 66 (NRA) vs. 70 (late): Break-even age is between 80 and 81.

In this example, if you wait until age 66 to take Social Security instead of taking it at age 62, you'll come out ahead as long as you live to at least age 77. The break-even age goes up, of course, the longer you wait. See the graph below for an illustration of sample break-even points.

Clearly, how long you expect to live will greatly influence your decision. Theoretically, it shouldn't matter when you start to receive your checks, provided that you have an average life expectancy. If you think you'll beat the average life expectancy, then waiting for a larger monthly check might be a good deal.

On the other hand, if you're in poor health or have reason to believe you won't beat the average life expectancy, you might decide to take what you can get while you can.

A quick note about life expectancy: At birth, our average life expectancy is about 78 years (about 75 for men and 81 for women), according to the National Center for Health Statistics.

However, if you are lucky enough to reach age 65, your average life expectancy rises to 82 for men and 85 for women. The average is even higher for married couples, with the odds of at least one spouse living to age 90 at over 60% for couples who reach age 65 together.

Remember, too, that the average is just that—you might be among those who live longer, in which case you may be glad you waited for a larger benefit.

3. Your spouse. Don't forget to take your spouse's age and health into account as you consider when to begin receiving Social Security, particularly if you're the higher-earning spouse. The amount of survivor benefits for a spouse who hasn't earned much during his or her working years could depend on the deceased, higher-earning spouse's benefit—the bigger the higher-earning spouse's benefit, the better for the surviving spouse.

4. Whether you're still working. If you take Social Security before your normal retirement age, earning a wage (or even self-employed income) could reduce your benefit. For example, if you're still working and you haven't reached your normal retirement age, $1 in benefits will be deducted for every $2 you earn above the annual limit ($14,640 in 2012).

In the year you reach your normal retirement age, it changes to $1 in benefits deducted for every $3 you earn above a higher limit ($38,880 in 2012), deducted only for income earned before the month you reach your normal retirement age.

Starting the month you hit your normal retirement age, your benefits are no longer reduced no matter how much you earn. Keep in mind, any reduction in benefits due to the earnings test is only temporary, analogous to "withholding." You will get the money back in the form of a higher benefit at full retirement age, so you shouldn't cut back on working or worry about earning too much.

That said, keep in mind that Social Security benefits may be taxable, depending on your modified adjusted gross income (MAGI). As your MAGI increases above a certain threshold (from earning a paycheck, for instance), more of your benefit is subject to income tax, up to a maximum of 85%.

For more information, see the SSA publication How Work Affects Your Benefits, and IRS Publication 915: Social Security and Equivalent Railroad Retirement Benefits.

In any case, if you're still working, you may want to postpone Social Security either until you reach your normal retirement age or until your earned income is less than the annual limit.

However, in no case should you postpone benefits past age 70. (You will receive your largest benefit by delaying retirement until age 70, so it never makes sense to wait past that age.)

5. The amount on your Social Security statement isn't what you actually get. Besides the potential for taxes to eat into your benefit, your Medicare Part B (and Part D, if applicable) premium will also be deducted from the gross amount.

For example, under the means-testing formula already in place, the 2012 Part B monthly premium deducted automatically from your gross Social Security benefit could range anywhere from $99.90 to $319.70 depending on your MAGI.

If SSA projections hold true, Medicare premiums will likely take an increasing share of your Social Security check. According to the Social Security Trustee's Report, by 2037, Medicare Part B and D premiums and co-pays on Medicare covered services will take 70% of the average Social Security benefit.

All the more reason to hold out for the largest gross benefit you're entitled to if you have other sources of income and expect to live a long life.

If you previously elected to receive early Social Security benefits at a reduced rate, you have the option of paying back to the government what you've already received. You could then restart benefits at a later date to take advantage of a higher payout. As of December 8, 2010, the SSA announced that this option would henceforth be limited to one year's worth of benefits.

For example, let's say you elected to receive early benefits at age 62 and you're now 63 and thinking of going back to work. You could stop receiving Social Security, pay back the one year's worth of benefits you received, go back to work, and then wait until a later age to restart your benefit checks at a higher level.

Paying back prior benefits is similar to buying an annuity, except that you don't have to pay any interest on the benefits you've already received and there are no fees (which is why the SSA decided to limit this option to only one year).

Whether it makes sense to take advantage of this option depends on your tax situation, age and life expectancy. Of course, you also have to come up with the repayment money. You might want to enlist the help of a CPA or another financial professional to help you crunch the numbers.

For important details about repaying benefits please read the SSA publication If You Change Your Mind. If you determine that it makes sense to repay your benefits, you can start the process by filling out Form 521: Request for Withdrawal of Application.

If you're skeptical (or downright cynical) about the future of Social Security, you may be inclined to take benefits as early as you can under the assumption that a bird in the hand is better than nothing. Healthy skepticism is understandable.

According to the most recent annual Social Security Trustees report, Social Security began paying out more than it received on an annual basis in 2010.² The SSA projects that beginning in 2036, Social Security benefits could be reduced by 25% and could continue to be reduced annually.

One scenario we might see (besides benefit reductions and tax increases) is means testing, where the amount of benefits could vary depending on income, assets, or some other measure of wealth. This could result in a middle-class squeeze: The wealthy aren't eligible but are fine on their own and the needy are entitled to receive full benefits, but those stuck in the middle get something less than hoped for. In any event, waiting to receive benefits would still result in a larger check, all else being equal.

If you're really worried about the future prospects for Social Security, that's all the more reason to save more for your own retirement—even if it means spending a little less now. Regardless of how much is left when you're set to retire, wouldn't it be nice to treat your Social Security benefit as icing on your retirement cake, rather than the main course?

If you have a choice and are in good health, it's probably best to wait as long as you can to take your benefits (but no later than age 70). There are many factors to consider, and deciding when to take Social Security can be complex. Get some help from your financial planner or tax professional if you need it.

To quote that famous Baby Boomer sci-fi icon Mr. Spock: Whatever you decide, may you live long and prosper!

1. Source: OASDI (Old Age, Survivors and Disability Insurance) Monthly Statistics.
2. Source: The 2011 OASDI Trustees Report http://www.socialsecurity.gov/OACT/TRSUM/index.html