Social Security

Optimize Retirement Cash Flow, Not Social Security

Social Security is a beautiful thing. What other lifetime fixed income annuity allows you to choose a starting age anywhere between 62 and 70, increases your lifetime income by 6% per year for each year that you defer your start date between 62 and full retirement age, or FRA, (66 to 67 depending upon year of birth), increases your lifetime income by 8% per year for each year that you further delay your start date between FRA and 70, and provides for potential annual cost-of-living adjustments (COLAs)?

Spousal and Survivor Benefits

The good news doesn’t end there. There can be a bonus payment if you’re married. When you collect your benefits, your spouse may be entitled to receive a spousal benefit. The payment is 50% of your FRA amount if your spouse is full retirement age and the amount exceeds the benefit to which your spouse is eligible based on his/her earnings record.

Furthermore, your benefits can potentially continue to be paid to your surviving spouse for his/her life when you die. If certain qualifications are met, this in effect converts your single life fixed income annuity to a joint life fixed income annuity at no additional cost to you.

Assuming that you were married for at least nine months at the time of your death and your surviving spouse is full retirement age, he/she will receive the greater of (a) 100% of your benefit, with a minimum of 82.5% of your FRA amount if you were receiving a reduced payment because of early retirement, or (b) his/her benefit based on his/her earnings record.

Breakeven Analysis – A Starting Point

When should you begin collecting Social Security? A starting point for answering this question is to prepare a breakeven analysis. The purpose of doing this is to compare projected annual and cumulative benefits using various starting ages.

To illustrate this, please see the attached example.  It assumes a couple, Earner and Spouse, ages 62 and 59, respectively. Earner’s age 66 FRA monthly Social Security benefit is $2,000, with $1,500, or 75% of this amount, payable if the benefit begins at 62 and $2,640, or 132% of Earner’s FRA amount, if Earner’s benefit begins at 70. To keep the example simple, benefit amounts are unadjusted for potential COLAs. The yellow in the cumulative column indicates the optimal cumulative benefits each year.

Per the spreadsheet, assuming that Earner begins collecting Social Security at age 62, his four-year head start enables him to accumulate greater benefits for 15 years than if he waited until 66 to apply despite the fact that his annual benefit of $18,000 is $6,000, or 25%, less than his age 66 benefit of $24,000. It’s not until 2031 when Earner is 77 and Spouse is 74 that their cumulative benefits of $288,000 are identical.

The tide turns in favor of starting Social Security at 66 for Earner beginning at age 78 through age 81 after which the starting age 70 cumulative benefits of $31,680 per year begin to exceed the age 66 cumulative benefits of $24,000 per year.

Optimize Retirement Cash Flow

A Social Security breakeven analysis is the starting point for determining when you should begin collecting Social Security. The decision should always be made within the context of a retirement income plan in order to determine which starting age is projected to optimize lifetime after-tax cash flow using various what-if scenarios. There are many variables that need to be considered that aren’t included in a Social Security breakeven analysis.

Although lack of financial resources and questionable health generally support earlier vs. later claiming, many individuals who apply for Social Security before FRA do so without considering the long-term impact of their decision on lifetime cash flow for themselves and their spouses, if married. While it’s tempting to begin receiving Social Security at age 62, assuming your FRA is 66 and excluding potential COLAs, you will permanently forfeit 25% to 43% of the monthly benefit that you, and potentially your spouse, would otherwise receive by deferring your start date to age 66 or 70, respectively.

See 3 Pitfalls of Social Security Optimizers

By Robert Klein

Robert Klein, CPA, PFS, CFP®, RICP®, CLTC® is the founder and president of Retirement Income Center in Newport Beach, California. Bob is also the sole proprietor of Robert Klein, CPA. Bob applies his unique background, experience, expertise, and specialization in tax-sensitive retirement income planning strategies to optimize the longevity of his clients’ after-tax retirement income and assets. He does this as an independent financial advisor using customized holistic planning solutions based on each client’s needs and personality.