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Should I collect Social Security before I tap into my 401(k)?

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Your decision ultimately depends on the expected return on investments in your IRA or other tax-deferred accounts.

Under most circumstances, you should postpone taking Social Security as long as possible. However, if you really need the money, try to estimate the returns you expect on investments in your IRA and 401(k)—annual returns above 5% would favor leaving those accounts alone and taking Social Security early. Below 5% would favor postponing Social Security and tapping your retirement accounts.

Taken in isolation, it makes sense to postpone Social Security as long as possible, assuming you have the discretion to do so, are in good health, and expect to beat average life expectancy. Also, in isolation, it's generally best to postpone withdrawals from tax-deferred accounts (such as 401(k) plans and IRAs) for as long as possible. That leaves taxable account money, which is generally the preferred place to start withdrawing, all else being equal.

However, there a few moving parts here that can’t be considered in isolation. If you need extra money to live on at age 62 and you want to avoid going back to work, and your only choice is between taking early Social Security or tapping tax-deferred retirement accounts, then you need to compare the numbers to see which makes sense.

Basically, your decision depends on how much return you expect to earn on your deferred investments—the higher the expected return, the more sense it makes to leave the IRA money alone and take early Social Security for the additional cash flow you need.

The level of return that favors going one way or the other will vary depending on the facts and circumstances—your benefit, life expectancy, etc.—but for someone who expects to live a long life, an expected annual return on tax-deferred assets below 5% or so would likely favor postponing Social Security for as long as possible. An expected return on deferred accounts above 5% would probably favor leaving it be and taking Social Security early.

As we've learned from the recent market downturn, it's impossible to predict your investment returns with absolute certainty. However, as a guide, a 2012 study by Charles Schwab Investment Advisory1 estimated the expected average annual returns for long-term investments (20 years or more):

  • Large-cap stocks: 6.5% per year
  • Mid/small-cap stocks: 8.0% per year
  • International stocks: 6.3% per year
  • Bonds: 2.6% per year
  • Cash investments: 2.2%

One important caveat to this data: These estimates are only expected averages—actual returns can vary widely in any given year. The greater the potential return, the greater the risk. For example, in the 10 years from 2002-2011, historical annual returns included the following highs and lows.2

  • Large-cap stocks: 28.7% and -37.0%
  • Mid/Small-cap stocks: 47.3% and -33.8%
  • International stocks: 38.6% and -43.4%
  • Bonds: 10.3% and 2.4%
  • Cash investments: 4.8% and 0.1%

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