Retirement at 62: Is Receiving Social Security Early Worth It?

By Thomas M Dalton

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JUNE 2006 - Millions of Americans are approaching one of the most important financial decisions of their lives: to begin receiving Social Security benefits at age 62, or defer those benefits until older. Retirees can receive a reduced monthly benefit at age 62, and progressively larger benefits for each month the retiree postpones benefits, up to age 70. Although many retirees don’t have the financial flexibility to defer Social Security benefits, those who do must compare the trade-off between receiving benefits for a greater number of years versus the cost of permanently reduced monthly benefits.

The examples provided here outline methods of analyzing the early-retirement decision. A simple analysis compares total expected lifetime benefits depending on whether a retiree chooses early retirement at age 62, normal retirement at age 66, or delayed retirement at age 70. A more realistic analysis compares retirees using early Social Security benefits to defer drawing down on retirement savings, allowing those savings to build for a longer period of time.

The analyses suggest that in all cases except for those with very low expected investment returns from individual retirement savings, it is economically beneficial for retirees to take Social Security benefits at age 62 and use these benefits to defer taking withdrawals from their retirement savings. Each retiree is unique, however, and all factors, including those affecting individual life expectancy, must be analyzed separately to determine the best choice.

The Retirement Decision

According to U.S. Census estimates, over 15 million people in the United States will be crossing the minimum Social Security threshold, age 62, over the next five years. Many of these people will be compelled to decide whether to collect Social Security benefits early or to wait until the normal retirement age.

The decision is among several options:

  • Begin receiving reduced Social Security benefits at 62, or sometime between 62 and the normal retirement age;
  • Wait for regular Social Security benefits at the normal retirement age; or
  • Wait even longer for increased Social Security benefits by postponing benefits until after the normal retirement age. At age 70 the decision is moot, because the monthly benefit does not increase by postponing benefits any longer.

Identifying the Lucky Decision Makers

Not everyone has the flexibility to defer collecting Social Security benefits. At present, a little over 72% of all beneficiaries are collecting a reduced benefit because of early retirement (see OASI Monthly Statistics, April 2005, Benefits in Current-Payment Status Table 3 at www.ssa.gov/policy/docs/statcomps/oasdi_monthly/
2005-03/table03.pdf
). Many of these people have no choice, due to economic reasons (e.g., they are unable to work because of health problems or can’t find suitable work). People who are fortunate enough to have a choice in the matter, however, must decide whether it is more economically advantageous to collect Social Security early, to collect at the normal retirement age, or to delay after the normal retirement age.

People with the flexibility to make this choice can be divided into two groups: those who will continue to work after age 62, possibly drawing additional funds from tax-deferred retirement accounts; and those who will stop working altogether, living entirely by drawing funds from another source, such as distributions from a tax-deferred retirement account after age 59 Qs . It’s important to distinguish between these two groups, because those who collect Social Security benefits and continue to work before the normal retirement age lose $1 of benefits for each $2 of earnings in excess of the specified limits ($12,000 in 2005). Once a person reaches the normal retirement age, there is no loss of Social Security benefits, regardless of earnings.

People who continue to work after age 62 must consider the dual downsides of receiving reduced benefits by collecting Social Security before normal retirement age and also further reducing benefits by earning income over the allowable limits. These downsides must be weighed against the upside of using their early Social Security benefits to delay the need to draw money from their retirement savings. People who do not work after age 62 generally need only compare the downside of receiving reduced benefits against the upside of using Social Security benefits to delay the need for drawing money from their retirement savings.

How Age Affects Social Security Benefits

A person’s normal retirement age depends on the year of birth. Under current law, the normal retirement age for people born in 1937 and earlier is 65. The normal retirement age for people born from 1943 to 1954 is 66. The normal retirement age for people born in 1960 and after is 67. People born between these benchmarks have a graduated normal retirement age per the detailed table in the “Retirement Planner” on the Social Security website (www.ssa.gov/retire2/agereduction.htm). The reduction in monthly benefits applied for early retirement is a sliding scale, ranging from a 20% reduction for people born in 1937 who retire at 62, up to a 30% reduction for people born in 1960 or later who retire at 62.

People born between 1943 and 1954 (with a normal retirement age of 66 years) reach age 62 beginning in 2005, and are now faced with the choice of beginning Social Security benefits early or deferring them to age 66 or beyond.

People who defer collecting Social Security beyond their normal retirement age will receive more than 100% of a full monthly retirement benefit, depending on how long benefits are delayed. For people who reach normal retirement age on or after 2008, the increase for each month of delay is two-thirds of 1% of the full retirement benefit, or an 8% increase for each year of delay. For example, if a person would have received $1,000 per month by retiring at his or her normal retirement age of 66, that person would receive $1,160 per month by waiting 24 months (to age 68) and $1,320 per month by waiting 48 months (to age 70) to collect Social Security. Delaying benefits past 70, however, adds nothing to a person’s monthly benefit. The percentage increase is less, on a sliding scale, for people reaching normal retirement age prior to 2008, dropping to a 1% increase for each year of delay for retirees reaching normal retirement age prior to 1982. A table presenting monthly benefit percentage increases for delayed retirement can be found in the “Social Security Handbook” (www.ssa.gov/OP_Home/handbook/handbook.07/
handbook-0720.html
).

The Simple Analysis

One simple way to compare the three basic alternatives—delay retirement until age 70, begin benefits at age 62, or begin benefits at the normal retirement age—is to ignore alternative uses of the money. In other words, simply look at which alternative gives the most cumulative amount of gross benefits over the expected life of the retiree. Actuarially speaking, a person who lives exactly as predicted should receive substantially the same cumulative amount of benefits regardless of the choice. Regardless of the statistics, a retiree’s expectations of his own longevity will drive the decision.

A spreadsheet is the most efficient way to compare the alternatives. For example, consider a person born in 1944, turning 62 in 2006, with a full monthly retirement benefit of $2,000. Further assume that Social Security benefits will increase by 2% each year (per the annual automatic cost-of-living adjustment; the actual increase for 2005 was 2.7%). Using the Social Security tables described above, the yearly and cumulative benefits for this person for the three basic alternatives can be estimated and compared.

Exhibit 1 graphs the relative advantage of delayed retirement, early retirement, and normal retirement at various life expectancies. Without considering alternative uses of money (e.g., delaying tax-deferred pension distributions), the retiree in this example who expects to live past 81 years will collect more lifetime Social Security benefits by delaying Social Security collection until 70. If the retiree expects a shorter life, collecting Social Security benefits at 62 will lead to a greater lifetime benefit.

The relative advantage will change if the retiree in this example collects Social Security benefits before normal retirement age, continues to work, and earns more than the limit for early retirement. There will be a $1 reduction of Social Security benefits for every $2 of earned income over the allowable limits until the retiree reaches normal retirement age (see “How Work Affects Your Benefits,” SSA Publication No. 05-10069, January 2005, at www.ssa.gov/pubs/10069.html). Assume that the retiree in this example earns an amount in excess of the allowable limits sufficient to decrease his or her Social Security benefit at 62 by 25%, which would mean earned income of about $21,000. Exhibit 2 illustrates that even with modest earned income at age 62, there is very little advantage in collecting Social Security benefits early. If the retiree expects to live past 76, waiting until normal retirement provides a greater cumulative Social Security benefit.

The Social Security Administration estimates that men who reach the age of 62 on average will live to just over 80 years, and women who reach age 62 will live to about 83 Qs (see the Period Life Table in Actuarial Publications of the Social Security Administration, www.ssa.gov/OACT/STATS/table4c6.html). Given the odds of living past 76 if a retiree is already 62, retirees who don’t need to collect Social Security at age 62—and who plan to earn amounts sufficient to cause a reduction in monthly benefits—should probably defer collecting benefits until at least the normal retirement age.

A Realistic Analysis

A more realistic analysis should consider the alternate uses of a retiree’s money. Specifically, many retirees have the flexibility of deciding whether to collect Social Security early and reduce the draw on retirement savings, thereby allowing undistributed funds to continue growing in a tax-deferred account. The cost of this strategy is that monthly Social Security benefits are permanently reduced.

Life expectancy is not the only important variable in this analysis. The expected rate of return on retirement savings is critical to the decision. The higher the expected rate of return, the more advantageous it is to leave retirement savings alone by drawing a reduced Social Security benefit at age 62. Again, a spreadsheet is ideal for comparing the alternatives.

Assume the same facts as in the example above: a person born in 1944, turning 62 in 2006, with a monthly Social Security benefit at normal retirement age of $2,000, and expected Social Security increases of 2% each year. Further assume the following:

  • The balance in the retiree’s tax-deferred retirement account at age 62 is $500,000.
  • Beginning at age 62, for living expenses the retiree needs an additional $30,000 annually in pre-tax dollars that will come first from any Social Security benefit, and second from a pension distribution.
  • The $30,000 annual need will increase each year by a 3% inflation adjustment.
  • The retiree’s gross income is high enough to cause 85% of Social Security benefits to be taxed, therefore all comparisons are in pre-tax dollars, ignoring the tax-exempt effect on 15% of Social Security benefits.

Using estimated Social Security benefits calculated by the Social Security Administration tables, the effect on the retiree’s tax-deferred retirement account can be estimated under these assumptions in the delayed, early, or normal Social Security benefit scenarios. The analysis can be further expanded to determine the effect of different returns within the pension plan; in this example, 8%, 5%, and 2%. These returns are roughly equivalent to what a retiree can expect given a reasonable range of portfolio allocations, from securities to savings accounts.

High return (8%). Assuming an 8% return by the tax-deferred retirement account, calculations in this example indicate that the retiree will always come out ahead by beginning Social Security benefits at age 62. The advantage of leaving retirement funds in a tax-deferred account earning 8% far outweighs the loss in Social Security benefits from early retirement. The enhanced Social Security benefit earned by delaying benefits until 70 (i.e., the 8% increase in benefits for each year of delay past the normal retirement age of 66) doesn’t have much appeal. Even if the retiree’s choice is between taking benefits at the normal retirement age of 66 or delaying benefits until 70, the retiree comes out ahead by delaying retirement only if she lives past 106. Exhibit 3 graphs the cumulative balances of the retirement account, assuming an 8% tax-deferred return, versus life expectancies under all three scenarios, focusing on this point at age 106.

Medium return (5%). Assuming a 5% return by the tax-deferred retirement account, the optimum strategy is early retirement at age 62—unless an individual anticipates living past 89. After that age, the strategy of delaying retirement until 70 becomes increasingly advantageous. Exhibit 4 graphs the cumulative balances of the retirement account, assuming a 5% tax-deferred return, versus life expectancy under all three scenarios.

Low return (2%). Delaying Social Security benefits becomes more advantageous if the expected returns from a tax-deferred retirement account are low. Exhibit 5 graphs the life expectancies at which delayed retirement at 70 and normal retirement at 66 become progressively more advantageous than early retirement at 62.

In this example, if a retiree expects to live longer than about 83 years, it becomes more advantageous to opt for delayed Social Security benefits. The downward sloping line indicates that, at a 2% return, the earnings are not enough to offset the withdrawals, and the retirement fund balance is decreasing.

Note that the average life expectancy for men who reach 62 years of age is around 80, while for women it is around 83 Qs . In this example, therefore, a strict adherent to statistical probabilities might advise a man to collect early Social Security benefits, and a woman to wait until age 70 to begin collecting benefits. It is more likely, however, that many individuals will optimistically estimate their own life expectancy as somewhat greater than the statistical averages.

Winds of Change

The issue of Social Security reform has been in the air of late. Analysis of long-range solvency proposals and proposed legislation can be found at the Social Security Administration website (www.ssa.gov/OACT/solvency). Any legislation passed in the near term could affect the retirees in the cohort described above by changing the early, normal, and delayed retirement ages, along with the sliding-scale tables that define monthly benefits. It is impossible at this point to predict how significant any legislative changes will be and whether they will affect individuals who are nearing retirement and making the kinds of decisions discussed above.

General Advice for a Personal Decision

As seen from the examples above, the decision to receive Social Security benefits before the normal retirement age is an individual matter, dependent on personal needs and assumptions. The decision is relevant only to retirees who have the financial flexibility to defer benefits until the normal retirement age or beyond.

Even though the decision is contingent on individual circumstances, at least two general conclusions are apparent. First, it’s probably not beneficial for someone who can continue to generate substantial earned income to elect for early Social Security benefits. The reduction in benefits for earned income over the allowed limits greatly reduces the advantage of receiving benefits over a greater number of years during the retiree’s lifetime. Indeed, the one-for-two dollar reduction in benefits is essentially a 50% surtax on earnings over the allowed limits. Furthermore, the retiree’s basic monthly Social Security benefit is permanently reduced because of the early retirement itself.

Second, retirees who intend to begin drawing on retirement savings at age 62 should carefully consider the earnings rate of their savings and whether it is cost-effective in the long run to use early Social Security benefits in lieu of draining their savings. Whether the cost of permanently lower Social Security benefits is worth an extra three or four years of benefits that are used to protect retirement savings depends primarily on the rate of return in those investments and the retiree’s expectation of longevity. Actuarially determined life expectancies suggest that for all but low investment returns, it is better over a lifetime to take early Social Security benefits and use these benefits to defer drawing down retirement savings.

Most people, however, probably believe they can “beat the odds” and live much longer than government-determined averages. The actual decision for a retiree will very much depend upon personal
perceptions.


Thomas M Dalton, PhD, CPA, is a professor of accounting and taxation at the school of business administration, University of San Diego, San Diego, Calif.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



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