Individuals nearing retirement can implement a number of strategies to cover living expenses during their post-working years. Although retirement plan distributions and pension payments are common, Social Security income is the most widely used income plan among retirees. The monthly benefit is a guaranteed amount a person can start receiving as early as age 62. Despite Social Security being a commonly used method in retirement income planning, various factors affect how much benefit an individual receives over his or her lifetime.
When to Take Social Security Income
Retirees can elect to receive Social Security benefits starting at age 62 or as late as age 70, although full retirement age varies depending on which year one was born. If an individual elects to take an early benefit, prior to their full retirement age, income is reduced by as much as 25%. Although the total amount of income checks received is higher than for those who wait until full retirement age, the total lifetime payment may be lower. At full retirement age, an individual receives a full benefit based on the amount of Social Security tax paid into the system through his or her lifetime, up to a maximum monthly benefit amount. Although fewer total checks are received, total lifetime payout may be higher. Individuals who are able to defer taking Social Security income until after full retirement age are given a delayed retirement credit each year past that age until age 70, equivalent to an 8% increase for those born in 1943 or later. This creates the fewest number of checks received but results in a much higher monthly benefit.
To determine the most appropriate age for a retiree to begin receiving income, calculating Social Security break-even age is beneficial.
Calculating Social Security Break-Even Age
When benefits are elected, a retiree makes a permanent choice, meaning benefits are reduced over the course of a lifetime, not just until full retirement age. As such, it may prove helpful to calculate the Social Security break-even age in an effort to determine when total benefits received equal the same amount under different age elections.
For example, if we assume the full retirement age for a retiree is 65 and he or she chooses to begin receiving Social Security income at age 62, his or her full retirement age benefit of $1,000 may be reduced by 20%, leaving the retiree with $800 each month. If the retiree's co-worker with the same birth date and similar earnings history elects to receive his or her benefit at full retirement age three years later, the benefit may equal $1,000 each month. For the first three years, the first retiree received a total of $28,800 (or $9,600 per year) while the second received nothing. Once the second retiree starts receiving benefits, he or she receives $200 more each month, or $2,400 more each year than the first retiree. The Social Security break-even age is 77, or 15 years after the first retiree elected to receive benefits. After this point, the second retiree earns more over his or her lifetime than the first.
Although mortality is an unknown, retirees who think they may live past the break-even age may want to defer taking Social Security benefits until full retirement age, while those who do not expect longevity may want to start benefits early.
Thomas Mingone, CHFC, CLU, AIF, AEP, CFS
Capital Management Group of New York, Pearl River, NY
Social Security payouts are designed to be actuarially equivalent for someone with average mortality, so theoretically, it should not make a difference when an individual starts collecting. Still, the break-even age, the age when total Social Security income from two retirement options is the same, can be good to know, as external factors may affect the actual worth of benefits received. These include inflation as measured by annual cost-of-living increases, the time value of money, probable investment returns, and marginal tax rates. Online calculators can offer a good starting point for estimating these variables.
But remember, personal factors affect the decision of when to file, too – health, familial needs, employment status – and a break-even analysis can’t capture these.