02 Oct How to calculate a breakeven point for Social Security

Q. When you calculate a breakeven point for Social Security benefits, how can you include investment returns in the calculation?
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A. Before getting into the details of your question, let’s review the options and trade-offs involved in claiming Social Security benefits either early, at full retirement age or as late as age 70.

Each of us has a Social Security Full Retirement Age (FRA), which depends on the year you were born. For most of us, the FRA is generally between 66 and 67. For anyone born in 1960 or later, the FRA is 67, said Gene McGovern, a certified financial planner with McGovern Financial Advisors in Westfield.

McGovern said at full retirement age, we’re eligible to receive what’s known as the Primary Insurance Amount, or PIA. The PIA is a monthly payment that’s based on your highest 35 years of earnings. That’s the number that appears in big bold type at the top of your Social Security statement.

Regardless of your full retirement age, you can start collecting benefits as early as age 62 or as late as age 70, he said.

“The trade-off involved in collecting benefits early is that your monthly payment is permanently reduced,” he said. “Benefits decrease by 6.67 percent a year for the first three years they’re claimed early. After that, they decrease at a somewhat slower rate, by 5 percent per year.”

At age 62, then, if your FRA is 66, your monthly benefits are reduced by 25 percent. If your FRA is 67, benefits at 62 are reduced by 30 percent, he said.

“On the other hand, if you delay taking benefits past your FRA, they increase by 8 percent of your primary insurance amount each year, until age 70,” he said. “Thus, if your full retirement age is 66, your benefits at age 70 will be increased by 32 percent. There’s no benefit to waiting past age 70.”

McGovern said at age 70, your benefits are a whopping 76 percent more than at age 62.

He offered this example: Jane’s full retirement age is 66, and her monthly PIA is $1,000. If Jane claims benefits at 62, her PIA is permanently reduced by 25 percent to $750 a month. If she waits until age 70, Jane will collect $1,320 a month, or 76 percent more than at age 62.

So the question is whether it’s better to claim smaller benefits early, to wait until full retirement age or to wait even further to age 70 and collect the largest benefit.

“Because benefits are adjusted up or down based on the age at which you claim them, it all works out pretty much the same—from an actuarial standpoint—whenever you begin collecting, because your lifetime benefits, on average, are designed to be about the same whenever you start,” he said.

However, Social Security bases its benefits on average life expectancy for the population as a whole. Since few of us are average, the ideal age to begin collecting benefits can vary dramatically with individual circumstances, including your health, whether you’re still working, whether you’re married, and whether you have other resources available such as savings or a pension, McGovern said.

“The so-called breakeven period is a calculation of how long it would take for the higher benefits collected at a later age to offset the loss of lower benefits collected at an earlier age,” he said.

He continued with this example. Assume that Jane decides to start her benefits at age 62 and collects $750 per month. Assume also that Jane has a twin sister Emma, who has identical Social Security benefits. Emma, however, waits eight years until age 70 to begin collecting $1,320 per month.

To keep things simple, we’ll ignore the annual inflation adjustments that Social Security recipients receive.

From age 62 to 70, Jane would collect eight years’ worth of benefits, or $72,000 ($750 x 12 months x 8 years), before Emma collects anything. Emma has given up that $72,000 in favor of collecting $570 more each month at age 70 ($1,320 – $750).

McGovern said if we divide that forgone $72,000 by $570, we get just over 126 months, or about 10 ½ years, as the breakeven period. That’s how long it will take Emma to make up for having waited. So at age 80 ½, Emma will break even in total benefits collected compared with what she could have collected starting at age 62.

“After the breakeven point, Emma will keep on collecting $570 more every month than Jane will,” McGovern said. “If Emma and Jane both live to age 95, Emma will receive about $99,000 more in total than Jane.”

Plus, if we factor in the larger annual inflation adjustments on Emma’s bigger benefit compared with Jane’s, the benefits of waiting to 70 are only magnified.

Now, to your question. These numbers don’t take into account the fact that Jane could have invested that $72,000 collected early, or avoided taking that money out of her savings. We’ve ignored the time value of money.

“What rate of return Jane could earn on those funds, with the same level of safety, inflation protection, and predictability as Social Security benefits, is debatable,” McGovern said. “Nevertheless, there’s no question that the breakeven point for waiting is pushed out somewhat if we consider the ability to invest the earlier benefits.”

How far the breakeven point moves depends on what assumptions we make about inflation and rates of return.

McGovern used this example: Assuming that Jane took her benefits at age 62 and invested them at 5 to 6 percent per year, with 2 to 3 percent annual inflation, Emma’s breakeven period compared with Jane would be pushed out another 3 ½ to 4 ½ years. It would now take Emma roughly 14 to 15 years, or to about age 84 or 85, to break even.

Lower rates of return or higher inflation would move the breakeven point considerably less.

On the other hand, after the breakeven point, the benefits—and the real rate of return—of having delayed increase rapidly throughout Emma’s remaining lifetime, McGovern said.

Keep in mind that this isn’t strictly an investment question. Longevity ultimately matters much more, both in terms of how much you’ll ultimately collect and in terms of the risk of outliving your money, he said.

McGovern said if you’re unmarried and delay benefits past age 62 but die before you begin collecting them, you’re out of luck. At the other extreme, if you live to age 100, the inflation protection and real rate of return you receive by delaying your benefits to age 70 are likely to be better than any other potential investment at mitigating longevity risk.

One last issue to consider is your marital status. According to the Society of Actuaries Longevity Illustrator, for a nonsmoking, 65-year-old married couple in excellent health today, there is a 74 percent chance that one of them will live to age 90. The chances that one of them will live to age 95 are nearly 50-50. Compare that with Social Security life expectancy estimates, which show that the average man reaching 65 today will live to age 84, while the average woman of the same age will live to about 86.5.

One spouse in a marriage, then, if the couple is otherwise in good health, has reasonable odds of living at least five to 10 years longer than the Social Security life expectancy averages for the population as a whole, McGovern said.

“That higher life expectancy argues strongly in favor of the higher-earning spouse in a marriage delaying benefits to age 70,” McGovern said. “That’s because the surviving spouse in a marriage receives the higher of their own or their deceased spouse’s benefit. Delaying, then, protects the surviving spouse by providing him or her with the highest possible lifetime income.”

In the end, the decision on when to claim Social Security benefits must be tailored to each person’s unique needs and circumstances.

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This story was originally published on Oct. 2, 2019.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.