When Should I Start Collecting Social Security Retirement Benefits?
At What Age Should I Start Collecting Social Security Retirement Benefits?
By Wayne M. Lenell, CPA, PhD
Social Security retirement benefits become available as early as age 62 and may be postponed until age 70. The question is, “When should I start collecting Social Security retirement benefits?
Before answering that question, it is important to dispel a common myth regarding the Social Security system. Many, especially younger people, believe Social Security will not be there when it is their turn to collect benefits. From one perspective, if that belief results in people saving more for their own retirements and not relying on Social Security, those people will have a more affluent retirement. The fact is, however, that Social Security is here to stay.
Current studies project that the Social Security system will become unable to pay the then-current level of promised benefits beginning in the year 2034. At that point, Social Security will have the ability to pay about 76% of promised benefits. Studies also show that from that point forward, the Social Security system can sustain that level for the foreseeable future. Perhaps the government will cut Social Security payments by 24% beginning in 2034. Doing so would maintain the financial integrity of the system for future generations. Cutting Social Security benefits by 24% is also political suicide and is a very unlikely event. When faced with this same dilemma throughout the history of the Social Security system, the government has always opted to take corrective action rather than reduce Social Security benefits to retirees.
In the past, when the government has been faced with inadequate funding for Social Security, it made one of three changes.
1. The government increased the tax rate. The government has increased the tax rate 19 times since the inception of the program in 1937. The last time the government increased the rate was in 1989 which resulted in the longest dry spell of rate increases in the history of the Social Security program. The initial tax rate was 1% with the employer matching the employee tax. The current (2020) rate is 6.2% with a corresponding employer match. To cover a 24% deficit between promised benefits and sufficient funding, the government would need to increase the tax rate to 8.153% for both the employer and employee.
The government would not necessarily need to increase the employer and employee rates in tandem. For example, the government could raise just the employer portion to slightly above 10% and leave the employee rate intact. Such a move is not without precedent. In the years 2011 and 2012 the employer rate was 2% higher than the employee rate.
2. The government has increased (usually in excess of the rate of inflation) the maximum amount of taxable earnings for purposes of the Social Security tax. In 1937, an employee stopped paying Social Security taxes once wages for the year exceeded $3,000. In 2020, that limit has increased to $137,300. Had the government increased the taxable limit in proportion to the consumer price index (rate of inflation), the limit would be only $54,675 in 2020 so it is obvious that the government is not shy about increasing the wage limit for Social Security tax purposes.
Instead of merely increasing the limit on taxable wages, the government could eliminate the cap. According to recent studies, eliminating the taxable limit for Social Security earnings would provide approximately one-half of the funding needed to pay promised benefits.
3. The government has delayed the year of eligibility for full benefits. For the first 47 years of the program, the full benefit age was 65 years. In 1983, the government began a phased-in increase in the eligibility age so that those born in 1960 or later do not receive their full retirement benefit until age 67. While this was a small gesture toward recognizing an increase in the longevity of the American population, a two-year deferral hardly accounts for the increased life expectancy we now enjoy in the United States. When people say, “60 is the new 40,” they are not far off. In 1937, the life expectancy at birth for a male was 58 years and 62.4 for females. In 2017 (the most recent year of statistics provided by the CDC), the life expectancy at birth for a male is 76.1 years and 81.1 years for females.
Instead of the earliest eligibility remaining at 62 and the highest benefit being paid at age 70, the government could, for example, increase the low point to age 70 with the highest benefit at 75, or some other more reflective age bracket than currently.
We can conclude that, since the government has a long history of making adjustments to guarantee Social Security benefits to those of whom were promised benefits, it is very likely that the government will act to secure future retirement benefits for Americans.
To address the question of what is the optimal age to begin collecting Social Security benefits, it is important to understand the increase or decrease in benefits associated with the age of the retiree at time of benefit commencement.
We are currently in the phase-in period adjusting the full benefit retirement age. The full benefit age for someone born between 1943 and 1954 is 66. For the next six years after 1954, the full retirement age increases two months each year, so someone born in 1958 would need to wait until age 66 and 8 months before reaching full retirement age.
Social Security calculates a retirement benefit based on the best 35 years of a person’s working career on an inflation-adjusted basis. It applies the average inflation-adjusted wages to a formula to determine a person’s full retirement benefit so if the person begins collecting Social Security benefits at the designated full retirement age, that person would receive the calculated amount. If a person begins collecting benefits sooner than full retirement age, the monthly benefit amount is permanently reduced. The formula used for the reduction of benefits is 5/9ths of 1% for the first 36 months below the full retirement age plus 5/12ths of the remaining number of months below the full retirement age. If a person defers collecting benefits past the full retirement age, the monthly amount is permanently increased at a rate of 2/3rds of 1% for each month benefits are postponed beyond the full retirement age.
The first factor in determining when to start collecting Social Security benefits is the time period it takes to recover postponed benefits. This factor considers how long it will take to recoup the lost potential Social Security benefits with a larger monthly amount in later years. As we navigate through the factors, we will use an example of a person born in 1958 who will turn age 62 in 2020 and with a full retirement benefit estimated at $2,000 monthly at age 66 and 8 months.
The earliest benefit year is 2020 at age 62. Using the Social Security formula, the monthly benefit would be reduced from $2,000 to $1,433. The retiree will receive 56 months of benefits totaling $80,248 between the ages of 62 and 66 and 8 months.
The full retirement benefit occurs at age 66 and 8 months in the year 2024 with a monthly benefit of $2,000. The retiree will receive $567 more per month than the benefit at age 62. It will take 142 months (nearly 12 years) to recoup the lost potential benefits at which point the additional monthly benefit is to the advantage of the retiree for the remainder of his or her life.
If the person, in the above example, defers benefits to age 70 in the year 2028, the monthly benefit would increase to $2,533. Using the Social Security formula, the retiree will receive $533 more per month than the benefit at age 66 and 8 months. By postponing benefits from the full retirement age, it will take the retiree 150 months (12.5 years) to recoup the potential lost benefits had the retiree commenced benefits at the full retirement age.
The analysis above does not factor inflation into the equation. Social Security benefits are adjusted annually to reflect changes in the consumer price index. To the extent that Social Security increases the benefits reflecting inflation, the recovery periods would decrease. The analysis also does not factor in any return on investment a retiree could earn if, instead of spending the monthly benefits, the retiree invested the benefits. Any investment return would increase the recovery period.
We can conclude from this analysis that if a retiree lives beyond age 82, the retiree would be financially better off delaying Social Security retirement benefits until reaching the age of 70.
Another factor to consider when determining when a person should start collecting Social Security benefits is the need for cash flow. If there is a genuine need for cash flow between the ages of 62 and 70, a person may need to collect Social Security benefits just to meet current expenses. Some factors to consider when making this decision are as follows.
● Collecting Social Security in times of financial need should not be the immediate default choice. A person should consider other sources of funding including: drawing down savings or investments, withdrawing funds from personal retirement accounts, or working part-time. If, for example, a person is laid-off from work, the person should not panic and make a life-long decision for a temporary situation.
● If the person is between ages 62 and the full retirement age (66 and 8 months in the example above), the amount of earnings the person may have is limited to $18,240 for 2020 (adjusted annually for inflation). If the person earns in excess of $18,240, Social Security reduces benefits by $1 for every $2 the earnings exceed the allowable maximum. There is a larger limit ($48,600 in 2020) for earnings for the year in which the person reaches full retirement age. Therefore, a person under the full retirement age who continues to have earnings (earnings does not include investment income or other retirement income), must be careful to keep earnings under the Social Security limit. If a person’s Social Security benefits are reduced because of earnings limitations, Social Security recalculates future benefits so that, eventually, reduced benefits are restored to the retiree.
● Some Social Security benefits may be subject to Federal and State income taxes. The Federal government taxes up to 50% of Social Security benefits on incomes between $25,000 and $34,000 ($32,000 to $44,000 for married filing jointly), and up to 85% of Social Security benefits when income exceeds $34,000 for single taxpayers and $44,000 for married filing jointly.
Conclusions. If a person has no immediate need for cash flow that cannot be met by other sources, and if the person is in reasonably good health and expects to live at least another 12 years, it is probably best for the person to postpone collecting Social Security benefits until age 70. If a person begins collecting Social Security benefits before full retirement age, the person must be cognizant of the annual earnings limit if the person continues to have earnings while collecting Social Security benefits.