Earlier this year, I took a call from Carl who is getting ready to retire within the next few years. His advisor was suggesting that upon retirement, Carl rollover his 401(k) to an IRA and start collecting his Social Security benefit at age 62. Carl wasn’t so sure so he wanted a second opinion. Carl and I talked for a while and determined that it might make more sense for him to draw down his retirement account and allow his Social Security benefit to collect delayed credits.
Carl thanked me for the conversation and said that he would pursue that course of action. But how many other “Carls” are out there taking advice from financial advisors without seeking a second opinion? Now I have nothing against financial advisors—after all, I was an advisor for six years—but sometimes there are other options that may be equally if not more appropriate for the investor than what the advisor is suggesting.
So when does it make sense to take Social Security early?
Well, for starters, it may depend on how long you expect to live. According to a breakeven graph, if your life expectancy is less than age 77 you would receive a greater lifetime benefit from Social Security if you started collecting at age 62. Another reason to collect Social Security early is so that you can preserve your retirement assets. Unlike a joint and survivor annuity, Social Security may not leave a benefit to your survivors so by preserving your retirement assets, you are increasing the likelihood of leaving a legacy for your heirs.
It may also have something to do with your retirement goals. For example, if your goal is to retire at 62, you may need the extra Social Security income in order to enjoy the lifestyle you want to have at that time. By the same token, if you did not have sufficient retirement assets, waiting may simply not be an option.
A fourth reason why an investor may prefer collecting Social Security early is because they do not trust the future of Social Security. According to the most recent Social Security Trustee’s report, the Social Security Trust Fund is projected to run out of funds by the year 2033. For those that decide to take Social Security early, it may simply be a matter of a bird in the hand being worth two in the bush.
So when does it make sense to delay taking Social Security?
Just as a short life expectancy may be a reason to take it early, a long life expectancy would be a good reason to take it later. According to the same breakeven graph, if a person expects to live beyond age 82, their projected lifetime benefits would be greater if they deferred the benefit until age 70—the latest you would want to delay benefits. It may also make sense to take Social Security later if you have a low tolerance for risk or a low level of confidence in the stock market.
Many investors become more conservative as they transition into retirement so they look to reduce their risk by reducing their stock exposure. One way they could do that is to simply reallocate some of their retirement assets to more conservative investments like corporate bonds, government securities, and cash, but with such low interest rates, it might make more sense to simply take a distribution and spend the money on retirement expenses so they can delay Social Security. By delaying Social Security, they increase their future retirement income, which is kind of like purchasing a deferred annuity.
And then there is of course a need for confidence in the continuation of Social Security beyond 2033. Now although I’m not one to say “never” when it comes to your federal government, I’m fairly confident that Social Security will continue in some form or fashion. That said, there will probably be some changes to the system over the next 18 years—just don’t ask me what those changes will be.
So why might a financial advisor want an investor to take Social Security early?
Many advisors are compensated for managing assets or selling investment products so there is an imbedded conflict of interest when it comes to an advisor recommending rolling over a 401(k) to an IRA versus spending down the 401(k) and deferring a Social Security benefit. In the case of Carl, he did not want to take a lot of risk with his assets, and he did not have a lot of confidence in the future of the stock market. He had plenty of retirement assets—enough to leave a legacy and supplement his income for the next eight years—and based on family history, he expected to live well into his 80s. When we discussed the idea of spending down his 401(k) and deferring his Social Security, he seemed to feel better about that approach.
Unless you hold a crystal ball, you will never know the perfect time to start collecting Social Security benefits. There are all kinds of articles written to help investors decide on when they should take Social Security, but in the end, it usually boils down to just a few things: how long you will live, how confident you are in the stock market and the Social Security system, and how much you have saved. If your advisor is not discussing multiple approaches, then perhaps it’s time to get a second opinion.