Retirement at 62: Is Social Security Early Worth It?

 

“From the earliest records of civilization, tax laws have taken away liberty more often than foreign invaders” Charles Adams

The Retirement Decision

According to U.S. Census estimates, over 15 million people in the United States will be crossing the minimum Social Security threshold, age 62, over the next five years. Many of these people will be compelled to decide whether to collect Social Security benefits early or to wait until the normal retirement age. This newsletter will attempt to shed some light on this decision.

The Options

In a recent study by Thomas M. Dalton, PhD, CPA from the University of San Diego, three basis options were analyzed:

Begin receiving reduced Social Security benefits at 62, or sometime between 62 and the normal retirement age.

Wait for regular Social Security benefits at the normal retirement age; or

Wait even longer for increased Social Security benefits until after the normal retirement age.

Factors to Consider

A person’s normal retirement age depends on the year of his or her birth. Under current law, the normal retirement age for people born in 1937 and earlier is 65. The normal retirement age for people born from 1943 to 1954 is 66. The normal retirement age for people born in 1960 and after is 67.

The reduction in Social Security benefits applied for in early retirement is a sliding scale, ranging from 20 percent reduction for people born in 1937 who retire at 62, up to 30 percent reduction for people born in 1960 or later who retire at 62.

Delaying benefits past 70, however, adds nothing to a person’s monthly benefit.

Those who collect Social Security benefits and continue to work before normal retirement age lose $1 of benefits for each $2 of earnings in excess of the specified limits ($12,000 in 2005). Once a person reaches the normal retirement age, there is no loss of Social Security benefits, regardless of earnings.

Assumptions

Assumptions used in the analysis are as follows: A person born in 1944, turning 62 in 2006, with a full monthly retirement benefit of $2,000. Further assume Social Security benefits will increase by 2 percent each year.

The Simple Analysis

One simple way to compare the three basic alternatives – delay retirement until age 70, begin benefits at age 62, or begin benefits at the normal retirement age – is to ignore alternative uses of the money.

Under this scenario, the retiree who expects to live past 81 years will collect more lifetime Social Security benefits by delaying Social Security collection until 70. If the retiree expects a shorter life, collecting Social Security benefits at 62 will lead to a greater lifetime benefit.

The relative advantage will change if the retiree in this example collects Social Security benefits before the normal retirement age, continues to work and earns more than the limit for early retirement. If the retiree earns income of about $21,000 and lives past 76, waiting until normal retirement provides a greater cumulative Social Security Benefit.

A Realistic Analysis

A more realistic analysis should consider the alternate uses of a retiree’s money. Specifically, many retirees have the flexibility of deciding whether to collect Social Security early and reduce the draw on retirement savings, thereby allowing undistributed funds to continue growing in a tax-deferred account. The cost of this strategy is that monthly Social Security benefits are permanently reduced.

Life expectance is not the only important variable in this analysis. The expected rate of return on retirement savings is critical to the decision.

Assuming an 8% return by the tax-deferred retirement account, calculations indicate that the retiree will always come out ahead by beginning Social Security benefits at age 62. The advantage of leaving retirement funds in a tax-deferred account earning 8 percent far outweighs the loss in Social Security benefits from early retirement. The retiree comes out ahead by delaying retirement only if he or she lives past age 106.

Assuming a 5 percent return by the tax-deferred retirement account, the optimum strategy is early retirement at age 62—unless an individual anticipates living past age 89.

Note that the Social Security Administration estimates that men who reach the age of 62 on average will live to just over 80 years, and women who reach age 62 will live to about 83.

General Conclusions

First, it’s probably not beneficial for someone who can continue to generate substantial earned income to elect for early Social Security benefits. The reduction in benefits for earned income over the allowed limits greatly reduces the advantage of receiving benefits over a greater number of years during the retiree’s lifetime. Indeed, the one-for-two dollar reduction in benefits is essentially a 50% surtax on earnings over the allowed limits.

Second, retirees who intend to begin drawing on retirement savings at age 62 should carefully consider the earnings rate of their savings and whether it is cost-effective in the long run to use early Social Security benefits in lieu of draining their savings.

Actuarially determined life expectancies suggest that for all but low investment returns, it is better over a lifetime to take early Social Security benefits and use these benefits to defer drawing down retirement savings.

Invitation

If you’re not a client yet, and you’d like to explore the option of developing a professionally managed investment portfolio comprised of no-load mutual funds, please give me a call.

I’d be happy to sit down with you and explain how as a fee-only investment advisor I can assist you in meeting your financial goals.

Marshall Sitarik - CFP
Ph. 407-977-3800