Evaluating Your Social Security Decision

Evaluating your Social Security decision can be tricky. Waiting to start benefits can pay off—if you live long enough. We’ll show you one way you can look at your situation.

Video: Evaluating Your Social Security Decision

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There aren’t a lot of choices you can make when it comes to your Social Security Retirement Benefits. In fact, you only have one choice–when  do you start?  So should you claim your benefits as early as possible, or should you wait?

Today we’ll dig into the numbers to show you how waiting can pay off in the long run.

Before we get into the weeds too far, let’s lay down a foundation. This is a simplified scenario, and there are often many different moving parts. We created this illustration using some generic and simple assumptions.

Also, for this episode, we won’t be talking about the impact this decision has on your retirement savings or other parts of your life. Those things should also be considered.

Your situation is unique. Please consult a professional before making any significant decisions.

A Case Study: Tom and Mary's Social Security

One of the biggest decisions Tom and Mary will make is when they start their Social Security. Do they retire this year? If so, it means they receive their benefits for a longer period of time.

But it also means, their benefits get reduced. In this case by 27%. In real dollar terms, it means they receive less.

Waiting means the discount shrinks, and they receive more each month compared to age 62. 

And if they delay their retirement to age 70, they qualify for delayed retirement credits. This is where your benefits increase by 8% for each year you delay your decision.

62 vs. 65: Evaluating Their Options

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Waiting to retire at age 65 means they receive $612 more per month. But they also receive fewer monthly payments over their lifetime. It will be worth it, if they live long enough. But how long do they have to live to “break even.”
 
This graph shows the cumulative benefits starting at age 62 (dark green line). And the total benefits received starting at age 65 (light green line). We are looking for where the two lines cross. This is how long they have to live to make waiting worth it.
Evaluating Your Social Security
If they live to age 80, waiting to take their Social Security makes sense. What about some other ages?

62 vs. Full Retirement Age (66 and 6 Months)

Evaluating Social Security
SOcial Security
The break even point pushes out to age 82. This makes the “payoff” of waiting a little less certain, but certainly within reason.

62 vs. Maximum Benefits (Age 70)

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Evaluating Your Decision
Delayed Retirement Credits make this interesting. The break even point is age 83. It might be too far away to make it worth considering. But, if they are healthy, they might want to.

Full Retirement Age vs. Maximum Benefits

Of course we should look at this option.  If they decide to work until their full retirement age, should they consider waiting until age 70 to collect Social Security?
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Evaluating Your Social Security Decision FRA v 70
With a break even point of age 84, they may not be comfortable taking the risk.
 
A lot of factors go into evaluating your Social Security decision. The break even point of your cumulative benefits is only one of them. If you would like help looking at your numbers, please click the button below (or give us a call). We would be glad to show you how you can include Social Security into your retirement plans.
Financial Planning

Neal Watson is a Certified Financial Planner™ Professional and a Financial Advisor with Fleming Watson Financial Advisors  He typically works with people who are planning for retirement.  Fleming Watson is a Registered Investment Advisory firm located in Marietta Ohio.  Our firm primarily serves Marietta, Parkersburg, Williamstown, St. Marys, Belpre, Vienna and the surrounding communities in Washington and Noble Counties in Ohio and Wood and Pleasants county in West Virginia.

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The Common Example.

Every advisor has used this example at some point in time.  But it doesn’t provide any practical answers.

The Impact Example 1 - Monthly Income

Here is what we typically see. People retire. They have this pile of money, and they need to get some income each month. In most cases, at least to this point in time, the money has been in the traditional 401(k) or IRA accounts.

They set up monthly distributions from their accounts. But most people don’t like to pay quarterly tax estimates. So they have taxes withheld from those withdrawals.

So if we use the $600,000 accumulation from the first graph, and use the 4% rule, it works out to a gross monthly income of $2,000.  Here is how we see this work in real life.

But with the Roth IRA, there are no taxes.  You get to keep the entire distribution.  

Over time, the impact of this can be huge.  Over the course of 23 years, the amount of taxes you pay can be significant.

Let’s say you start at $2,000 per month.  You increase it each year for inflation.  Over 23 years, you’ll take total distributions of $750,000.  Of that, $150,000 would go to the state and federal government.  With the Roth, it all stays in your pocket.  That’s a pretty big impact.

 

The Impact Example 2 - Large One-Time Distributions

Here is the second way a Roth IRA would impact your retirement.  People will often need to take a larger one time distribution from their IRA. Maybe it is a car purchase, or a major home repair, or a vacation. They may call and need $10,000.

 If that money comes from a traditional IRA or 401(k), we  often have to “gross up” the distribution. They want to NET $10,000. That means we have to increase the amount they take out to cover thetaxes.   In this example, to get $10,000 they have to actually withdraw $12,500. The government gets that $2,500.

But if you use a Roth IRA, you take out $10,000 and the $2,500 stays in your account.

The Impact Example 3 - Required Minimum Distributions

We still see people who don’t depend on their IRA’s for income. And then they get to age 70 1/2 and get a nice tax surprise.

If the money is in a Roth, no tax surprise.

This also impacts inherited IRAs. You do have to take money from an inherited roth account. But unlike the inherited IRA, you don’t have to pay taxes on those withdrawals.

At least your kids will be glad you have the Roth IRA to pass on to them.

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The Worst Outcome: Running Out of Money During Retirement

One of the things we talked about in a previous episode, was how your initial withdrawal rate impacts how long your savings will last. Unfortunately, we have seen people run out of money in their retirement. The primary reason they did–they withdrew too much money.

You see, if you don’t take money out of your nest egg, there is a very small chance of seeing your account values go to zero. But when you start taking income, you introduce that risk.

The “safe withdrawal rate” has been a hot topic in the financial planning world for decades. It continues to be the subject of many debates. The “holy grail” we are looking for is how much income you can take, and not run out of money.

The Basics of the 4 Percent Rule

What we have recommended the past 20 years is the “4 Percent Rule”.  It’s pretty simple to compute, really. You take what you have accumulated over time, multiply it by 4%.  And, then divide that by 12.  That’s the monthly gross income you take from your savings. 

Why Do We Use the 4 Percent Rule?

Two reasons:  There’s a lot of research on this subject, and our own real life experiences.

We live in a world where investment returns are sometimes negative and always unpredictable.

You see, if those negative returns happen early in your retirement, things can get dicey.  And if we have back to back negative years early in retirement…..Yikes that’s a whole different thing.

This is what people call the sequence of returns risk. If you retired at the end of 1994, and had 5 straight years of 20% gains in stocks…things looked really good. But, if you retired at the end of 1999, the picture was much different.

You pick a year to retire, and you have no idea if the next 12 to 24 months are going to be good or bad. And unfortunately that has a huge impact on your chances for success.

Let’s look at some real life historical situations. There are two major factors here: withdrawal rate, the annual percentage you take from your savings. And the allocation, the mix between stocks and bonds.

We’ll look at the three WORST bear markets in my lifetime, and I was born in 1971, so that’s where we start.

(Note, all allocations are 50% Stock 50% Bond, rebalanced annually. Stock Market returns are represented by the S&P 500 Total Return and bond returns are the annual total returns of 10-year Government Bonds.  Rates of return illustrated are not guaranteed, and past performance does not predict future results)

1973-74 Bear Market

Top to bottom the stock market dropped just under 50%. There were two straight negative years. The 4% withdrawal rate is the dark green line. The year end values grew significantly over the next 20 years.

With the 5% withdrawal rate, things still worked well, but growth was more subdued. And at 6%, which is the light grey line, the portfolio was the initial amount two decades later. Not a failure, but probably not ideal either.

The Dot Com Bust: 2000-2003

It featured three straight years of negative returns. Total drop of roughly 50% in the stock market. The years that followed also included the great financial crisis. This 19 year period is the worst since the great depression.

The 4% withdrawal rate survived. The account value was below the initial investment. but it didn’t go to zero either.

The 5% withdrawal rate isn’t a complete failure and the 6% withdrawal rate goes to zero….Not good.

Great Financial Crisis: 2008-2009

And if you retired at the end of 2007—57% top to bottom decline in the great financial crisis…

The 4% withdrawal rate, has worked out, as has the 5% withdrawal rate. But 6% is worth less than the initial investment just over a decade later.

More Supporting Data

JP Morgan has provided some additional research which shows the probabilities of success of various withdrawal rates and various allocations.

Their research shows, somewhat conservative portfolios create better chances of success.  But it is worth pointing out, being too conservative in some situations can also increase your longer term risk.  Something to keep in mind.

One Last Thing: There are No Guarantees

Starting at a 4% withdrawal rate does not guarantee success. You’ll notice none of these scenarios show a 100% probability of success.  Things can happen which could be far worse than anything we’ve seen before.

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How Does Your Age Affect Social Security?

We are eligible to begin Social Security retirement benefits at age 62. But if we retire before our normal retirement age, our benefits get discounted. The discount can be as much as 30%.
 
Delaying Social Security beyond normal retirement age means larger benfeits. Each year we delay, our benefits increase by 8%.
 
The income you need from savings depends on how much Social Security you receive. If you get less from Social Security, you need more investment income. When your investment income gets too high, you increase the risk of running out of money.
How Does Your Age affect Your Retirement

A Case Study: John and Patty

John and Patty are both 60 years old. They have accumulated $330,000 in their retirement accounts. Between contributions and earnings, their accounts should grow by $15,000 each year.

At normal retirement age, John will receive $2,000 per month in Social Security benefits. Patty will receive $1,500.

Remember, every year everything you buy costs more.  So John and Patty will need more income later in retirement.  

Let’s see how the age they choose to retire impacts the financial parts of their retirement.

how does your age affect your retirement

Click image to enlarge

Age 62 WD Rate
A 6.5% Withdrawal rate is high. It increases the risk of running out of money.
 
What happens if they wait?
Age 65

Click image to enlarge

Age 67 WD Rate

Better, But Still Not Ideal

Waiting an additional 3 years does two things.  It reduces the Social Security discount.  And, it gives them a chance to save more.

As a result, they need less income from their savings. And because they have more in savings, the withdrawal rate is better.  But it still isn’t ideal.

Age 67

Click image to enlarge

Age 67 WD Rate

That's Much Better

Now both John and Patty receive their full Social Security benefit.  And the additional years of compounding also help.  Now the withdrawal rate is 4%, which has a higher probability of success.

For good measure, let’s look at what happens if they wait until age 70.

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Click image to enlarge

Age 70 WD Rate

How Does Your Age Affect Your Retirement?

Time can be your greatest asset. And this is especially true if you aren’t as prepared for retirement as you hoped to be.

Early retirement discounts in Social Security benefits work against you. It places more responsibility on your nest egg for your income needs. And we believe the biggest threat to your retirement savings is your withdrawal rate.  

If you are able, working a few extra years should improve your retirement picture.  Those early retirement discounts disappear.  And the extra time you have to save won’t hurt either.

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