We want YOU to understand when to take Social Security

Aaron Bauer

He’s always been a strange uncle and now he’s saying he wants YOU to help with a few chores around the house.

But nothing is ever easy with this guy.  He offers to pay you twenty dollars in two years or thirty dollars in five years. Pulling out five different charts, he says his payment plan is all very simple, and points to numbers like a mad scientist.    Words like “indexing”, “inflation”, and “credits” fly like spittle from his mouth.

Cautiously you back away, hoping against hope that he will put himself to sleep with his ranting.  You mumble that you hear someone calling, and turn: tumbling, fleeing, running, sprinting.  You’re safe.  For now.

Sadly, most Americans approaching retirement don’t have this option.  They must confront the intricacies of Uncle Sam’s Social Security head on.  And while it would take a novel to fully explore the pros and cons of different filing strategies, I hope to analyze one of the more common ones: out-investing Social Security.

The strategy goes like this: take Social Security at the earliest possible age (62) and reinvest the benefits, with the intent of using market returns to exceed the penalty for starting benefits early.  There are some advantages to this tactic.  It creates an asset reserve that can be used for expenses or gifting during the retiree’s lifetime.  If the retiree dies young, he or she will have the benefit of having received more Social Security Security and more investment returns.  And even if they live a long life, excellent returns on their investments may overshadow the loss to Social Security benefits.

However, there are several counterarguments.

The first is that Social Security itself offers very competitive returns.  Each year benefits are delayed after 62, they will increase anywhere from five to eight percent.  This is simple interest rather than compound, but over an eight year period the difference isn’t severe.  To get similar average annual returns from an investment portfolio requires aggressive allocations (7% annual returns or more), which of course introduces significant risk.

That brings us to the second point: Social Security is…well, secure.  That’s the point of the program.  It guarantees income for retirees.  It rises with inflation. The five to eight percent annual increase for delaying benefits doesn’t require tactical investment.  It doesn’t require timing the market.  It just requires waiting.

The third argument is that not all money is created equal.  Social Security income automatically receives tax advantages.  The IRS can only tax 85% of it.  Many states don’t tax it at all (including Wisconsin).  Any money reinvested from Social Security may well be taxed again, if it’s put in a brokerage account.  If one is picking a revenue stream to protect, Social Security has a dollar-for-dollar advantage over traditional investments.

On balance, then, it is unlikely that a retiree will be able to safely out-invest Social Security by taking benefits early.  The annual increase for delaying benefits is already quite generous and nearly in line with market returns.  And when viewed as an investment vehicle, Social Security is about as safe as they come, with tax advantages to boot.  So why would anyone ever start it early?

Well, lots of reasons, actually.  We’re discussing a specific scenario, but there are many others.  Some are forced into retirement early and need benefits as soon as they can get them.  Others have looked at their family history and anticipate a short lifespan.  Many value the control they have over their assets by protecting them with an early income stream.  And some aren’t even sure there is going to be Social Security benefits in twenty years.

I can’t break out a crystal ball on that last point, but I do know this: Social Security is complicated, and retirement planning even more so.  If facing down Uncle Sam and his migraine inducing payment plan doesn’t sound like your cup of tea, come in and see one of our advisors.  They’re more than willing to help.