Social Security for millions of Americans will end up being one of their largest assets if you add together all the benefits an individual will receive over his or her lifetime. So it’s unfortunate but no surprise to Independent Financial Planning that nearly half of Americans make the big mistake of taking social security benefits early. How you manage taking social security benefits will make a huge difference in the total sum you will receive. It’s also true that individuals and married couples (and divorcees) with the higher incomes stand to gain or lose the most from their decisions regarding social security.
Independent Financial Planning has been running social security analyses for clients and most often the discussion will turn to finding the break-even between taking benefits earlier as opposed to later. As Laurence Kotlikoff says, trying to find the break-even is the wrong question. The best understanding of social security is that it is an insurance system. Life insurance insures against a premature death, home insurance against a flood or catastrophe, car insurance against an accident, etc. The question for social security is, what is it insuring against? Longevity. The possibility that you will live into your 90s or longer. You don’t buy any kind of insurance for the break-even (because if you did you probably wouldn’t buy it or would never buy enough) you buy it because it would be disastrous without it. Insurance is risk transfer – low probability events that would have enormous impacts.
Life expectancy can give you the norm of what to expect for yourself. Life expectancy is always changing but roughly for men it is 81 or 82 and women 83 or 84 on average. But insurance is for when the average is broken so if you live to be 99 it would be good to have additional insurance (a higher social security payout) to cover it. So what is the one big mistake? Taking social security early and having a reduced benefit for the rest of your life.
At Independent Financial Planning when I talk with people who have already elected to receive benefits before we meet, it is often one of three reasons. The first and least common is that the financial position they were in at the time was difficult and that immediate infusion was so desirable that they took it early. The second and most common is that they reviewed a break-even analysis and thought they were going to invest the amount received from 62 to 70 in the market and that was going to be their best outcome. The third is that they thought social security is a broken system and that taking it early they were going to get more out before it went bust. Hopefully none of you reading this are facing the first issue but if you are, please contact me and we’ll probably be able to find better solutions than taking social security early. Those of you in the second bucket we already addressed – consider social security an insurance policy rather than a break-even analysis (and in my experience the bright and wondrous hope of saving all of social security rarely happens and at the end of the day the saving schedule doesn’t work to plan). Those of you in the last, yes the system is broken, but social security is already a part of the federal budget and will likely simply grow. There is still little political will to make any changes to the program. In today’s political climate there is just as good a chance to expand social security and its public funding costs than to curtail it and fit into the current funding environment.
Don’t make the big mistake of taking social security early. Next week, I’ll address my favorite social security strategy for married couples or divorcees, the “file and suspend.” Until then watch this short and helpful video by PBS about social security and contact me if you have any questions.
