Deciding when to claim Social Security can have a significant effect on your retirement income. Learn how to help maximize your benefits.
For many Americans, Social Security is a critical source of income in retirement—offering guaranteed, inflation-adjusted monthly income for life. However, the age at which you decide to claim those benefits can make a big difference in how far they go to support your retirement income goals.
Maximizing your Social Security benefits requires that you factor in:
- unknown information, such as your longevity and that of your spouse;
- known information, such as your health status and level of retirement preparedness; and,
- information about the possible contingencies that would most strain your finances.
In short, figuring this one out is actually quite complex. Here’s what you should know.
Delaying Social Security: Pros and Cons
For those born after 1960, the Social Security Administration defines full retirement age as 67 years old. However, benefits can be claimed as early as 62 or as late as 70, with certain penalties and inducements associated with early claiming or deferring of benefits—namely, a reduction or increase in the monthly benefit amount.
The size of these benefit adjustments is far from insignificant: Claiming at 62 reduces monthly benefits to just 70% of one’s full retirement-age benefit, while claiming at 70 increases it by 24%. Put another way, the monthly income provided when claiming at 70 is a sizable 77% higher than the income provided when claiming at 62.
Delaying benefits, however, means going years without income from Social Security. Among the more important drawbacks of this type of strategy is that it increases the strain on other parts of the retiree’s balance sheet used to sustain lifestyle expenses during those years.
Maximizing Your Benefits: Longevity Matters
Your expected longevity is among the most significant factors when deciding when to claim Social Security. Generally, the longer one’s life expectancy, the greater the benefit of delaying benefits when measured in cumulative benefits received.
Of course, it isn’t possible to precisely predict your lifespan at the point when filing decisions must be made, but you can consider whether your health status and family history suggest heightened prospects of an extremely lengthy or short retirement.
Those who live past 77 will benefit from delaying benefits at least until their full retirement age (67), as that will result in greater cumulative income than claiming sooner. Based on recent actuarial tables, roughly three-quarters of people who are currently 65 will live to 77, and the fraction is higher for those in the highest deciles of wealth and educational background. Similarly, the age at which delaying claiming to 70 results in greater cumulative income than claiming at 67 is 81—about the average life expectancy for a single male today at 65. And of course, the benefits of delaying go up the longer past average life expectancy that you live. This is particularly important considering extended longevity scenarios are the most likely circumstances to put a retiree’s finances at risk.
Balancing Income Sources
The flip side of the potential benefits associated with delaying Social Security is that you must rely more on other sources of income for the intervening period. The degree to which that is desirable will vary based on personal circumstances and preferences. For some, this might mean remaining longer in a job they find fulfilling. Not only would this provide income to sustain one’s lifestyle while deferring benefits, but it would also mean making additional Social Security contributions—and therefore potentially receiving even higher benefits when they are ultimately claimed.
Others may elect, or be forced, to retire earlier, potentially years before higher Social Security benefits are available. In this case, retirees will often need to make larger withdrawals on investment accounts to offset the deferred Social Security income. While this means foregoing market returns on the withdrawn savings, it’s often a good trade-off. Our analysis suggests that deferring Social Security claiming may offer the equivalent of a 6.3% annualized return1 (with no market risk), which is substantially more than the expected return for investment-grade bonds and even most equities, according to Morgan Stanley Wealth Management's Capital Market Assumptions. What’s more, unlike stocks and bonds, the growing benefits are inflation-adjusted for any cost-of-living increases in the interim. That can make an enormous impact on the value of deferral.
Accelerating withdrawals from an investment portfolio to sustain a strategy of deferring Social Security benefits comes with an important drawback known as “sequence-of-returns” risk: Withdrawing funds during a possible market drawdown reduces the ability of your portfolio to participate in any subsequent rebound, and the impact of locking in those losses can be most consequential if they occur during early retirement.
What Strategy Makes Sense for You?
Balancing these concerns must be done within the context of one’s holistic retirement strategy. For example, our analysis has found that your personal level of retirement preparedness can significantly influence whether deferring benefits is worth the additional sequence-of-returns risk it may entail. For less prepared investors, claiming Social Security earlier can help reduce sequence risk and any associated income shortfall that may occur later in retirement.
There is no single best answer for how to claim Social Security benefits. Rather, the right decision depends on your personal circumstances and preferences, including the impact of taxes. (As a general rule of thumb, planning a consistent level of taxable income across time can help save on tax expenses.) But regardless of the claiming strategy you choose, the most effective approach to retirement income will incorporate thoughtful financial planning and a holistic, tax-efficient view of all sources of funds. Connect with your Morgan Stanley Financial Advisor and tax advisor to discuss what strategy makes the most sense for you.
