Should you focus on Social Security break-even analysis in your retirement?
The term break-even analysis often comes up when talking about when to claim Social Security benefits.
I often hear pre-retirees say things like “I’d have to live to age fill-in-the-blank to make it worth it to delay benefits.”
That may be true, but none of us can really predict how long your retirement will last.
Much of the information in this episode comes from an article written by Jim Blankenship for MarketWatch.com titled When should you file for Social Security? Don’t be fooled by the ‘break-even’ analysis.
A break-even analysis is useful for comparing investments, but “Social Security is not an investment, it is insurance.”
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Social Security Basics
Your Social Security benefits are generally based on your average income over your lifetime and your age at the time you file for benefits.
You can start claiming benefits anywhere between ages 62 and 70, and the longer you wait, the higher your monthly payment will be.
You can elect to take lower payments over a longer period of time by starting earlier, or you can take higher payments over a shorter period of time by delaying benefits.
Since most of us don’t have a fortune teller accurately predicting how long our retirements will last, It is generally recommended to treat Social Security as the insurance policy that it was intended to be.
Every situation is different, but in general, I recommend claiming Social Security only when that income is needed to support your retirement lifestyle.
Social Security, also known as Old Age and Survivors Insurance (OASI), is an insurance policy that covers you in the event that you live longer than expected.
To use an extreme example, you may not have planned for your IRA to cover all of your expenses if you live to be 120 years old, but Social Security will continue to pay you, even if you do live to be 120.
Note: I talked about the idea of Social Security running out of money in Episode 40, and how unlikely that really is, which I’ll link in the show notes.
An Example Couple
The article from MarketWatch talked about an example couple:
- The husband is a 63 year-old man who is getting ready to retire and wants to claim Social Security benefits now to supplement the household expenses.
- His wife is 58 and will still be working for several more years.
In their situation, their financial advisor suggested the husband wait until at least full-retirement age, or even age 70, to claim Social Security.
There are many factors that played into this recommendation.
- The husband is the higher income earner. His Social Security benefit would be about double his wife’s benefit.
- His wife is 5 years younger than he is and is statistically likely to outlive him by several years.
- His wife’s income only covers about half of their current living expenses. This means if he doesn’t claim Social Security now, he will have to withdraw money from his IRA.
He is concerned that the IRA is all the money they have saved for retirement, and once it’s gone, it’s gone.
After hearing the advisor’s recommendation, the husband noted that he had done a break-even analysis.
He had determined that he would have to live until at least age 80 for it to pay off to delay Social Security benefits.
He also said he would rather have the Social Security money now and save the IRA for later.
He’s thinking of Social Security as an investment, which it is not.
The article compared claiming Social Security to insuring your home against fire.
It went on to say, you wouldn’t do a break-even analysis to determine the likelihood of your home burning in a fire based on the history of home fires in your neighborhood.
No, you buy the insurance to cover the unexpected.
Social Security is not an investment designed to provide you with the most income over your lifetime. It’s meant to provide a source of income in the event that you live longer than expected.
And yes, I understand it has become the only source of income for many in retirement, unfortunately
Comparing an IRA with Social Security
- An IRA is a specific amount of money. That money may grow over time, but there is nothing replenishing that fund once you begin taking significant withdrawals from it.
- 100% of IRA withdrawals are taxed as ordinary income (assuming the IRA consists of only deductible contributions and the growth - Roth IRA withdrawals are NOT taxable).
- Investments in an IRA are not generally guaranteed to retain their value or grow over time.
Social Security Insurance
- At most, 85% of Social Security benefits are taxed as ordinary income. Depending on your total income, as little as 0% of your benefits could be taxed.
- Social Security is adjusted most years for annual cost of living increases. This is an automatic action that is coded into law.
- Social Security will provide income for your entire life.
- If your spouse lives longer than you do, your spouse will continue to receive the higher Social Security benefit for the rest of their life.
You have been saving during your working years to pay for your retirement. This is what those savings were intended for.
For every month that you delay claiming Social Security, you will have higher income for the rest of your life, and possibly your spouse’s life.
A CERTIFIED financial planner™ professional can help you plan for your retirement. Schedule a call today so we can talk about your retirement situation.