Most retirees are giving the government a costly gift by taking Social Security too early. They may lose a whopping $180,000 in benefits, according to a new study published by the National Bureau of Economic Research
“Virtually all American workers age 45 to 62 should wait beyond age 65 to collect. More than 90 percent should wait till age 70,” write the authors, David Altig with the Federal Reserve Bank of Atlanta and Victor Yifan Ye and Laurence J. Kotlikoff of Boston University.
If you don’t put some thought into your decision about when to accept your benefits, you and your family may lose out big time. Don’t cheat yourself!
Taking benefits early assumes you’ll have a short lifespan. Delaying them is betting you’ll live long enough to make up for the years you delayed taking benefits. It’s usually a less risky bet because you don’t want to outlive your savings. If you have a terminal illness or pressing financial needs, you may, however, need to tap your benefits early.
The numbers are compelling. If you were born between 1943 and 1954, your full retirement age is 66, meaning you’ll receive 100% of your monthly benefit then. At 70, the maximum age for starting benefits, you'll get 132% of the full benefit. If you start at 62, you may get only about 70% of your full benefit.
Furthermore, if you take payments early and die before your spouse, he or she may get lower survivor benefits. Another potential drawback is that if you’re working even part-time when you start receiving payments, you may be in a higher income-tax bracket (federal and state) than later on when you’re fully retired.
If want to retire early, you’ll need a plan to close the income gap you may have until you start receiving Social Security.
Fortunately, interest rates are much higher than they were a year or two ago. Today, your savings can create much more income, and that makes delaying Social Security more feasible. There are many ways to generate income: money-market funds, bonds of various types, dividend stock, bank certificates of deposit, and various types of annuities. The latter, often overlooked, have distinct advantages.
Fixed annuity can plug income gap until Social Security starts
For instance, suppose you decide to put off taking benefits for five years and you can afford to salt away $200,000. As of August 2023, you could buy a five-year fixed-rate annuity (also called a multi-year guaranteed annuity) that yields up to 5.52% and allows penalty-free 10% annual withdrawals beginning in the second contract year. (Most but not all fixed annuities allow for some type of annual penalty-free withdrawals.) Therefore, in year two you can take out up to $21,104.
This strategy can work if you’re at least 59½. Otherwise, you’ll pay a 10% IRS penalty on annuity interest received before that age.
This amount will decline in the following years because the interest payments won’t fully cover withdrawals. If you withdraw the maximum amount allowed in contact years two through five, at the end of the five year guarantee period, you’ll still have about $171,662 in principal coming back to you. Over the five years, you’ll also have received approximately $78,255 in total withdrawals, of which $49,917 was interest earnings.
While today you can find a five-year bank CD that yields almost as much as a fixed-rate annuity, with CDs, you usually can only receive interest penalty-free. If you take out any of the principal, you’ll pay a substantial penalty for early withdrawal. The CD thus won’t generate nearly as much available income, but you would, however, have your full principal intact after five years.
Or you can choose an income annuity
With an immediate annuity, you make a single deposit with an insurance company in exchange for a stream of guaranteed income. It usually has no cash surrender value after purchase.
Most people buy lifetime immediate income annuities. However, if you’re concerned with plugging an income gap until you receive Social Security, you may want to choose a set income term, anywhere from five to 20 years. This is called a “period certain income annuity.”
Here’s an example. Joe, age 65, retires and invests $200,000 in a five-year period certain immediate annuity so he can delay taking Social Security until 70. He lists his wife as the joint annuitant so she will continue to receive any remaining payments if he dies before the five years are up.
Joe will know exactly how much he’ll receive. Currently, he can buy an annuity that will pay $3,687.50 per month, including $3,333.50 in tax-free return of principal and $354.00 of taxable interest. After five years, the annuity will be done and will have no cash value. But it will have done its job, and hopefully, he won’t have spent the entire principal he got back.
Of course, Joe could just put his $200,000 in a money market account and make withdrawals as required. That’s convenient, but there’s a risk. Money market rates are currently high, close to 5.00%. But will they be that high two, three or five years from now? Probably not. The annuity payments are set and guaranteed.
It doesn’t need to be all one way or the other. Joe can split up his $200,000 between fixed-rate and income annuities if he likes.
Don’t cheat your future self
While the study clearly shows that the vast majority should wait until 70 before starting benefits, there’s no one-size fits all. Some people may need to claim early, but even for them, delaying benefits until 63 or 64 or 65 is often better than starting at 62.
When to start taking benefits is a bit of a roll of the dice. There’s no way around that. But you’ll get the best odds by considering all factors instead of making a rash decision.
You probably paid a lot into Social Security over your lifetime. Don’t cheat yourself.
Ken Nuss is the founder and CEO of AnnuityAdvantage, a leading online provider of fixed-rate, fixed-indexed, and lifetime income annuities. Ken is a nationally recognized annuity expert and widely published author. A free rate comparison service with interest rates from dozens of insurers is available at https://www.annuityadvantage.com or by calling (800) 239-0356.
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