Personal Finance

Stock market volatility could kill this risky Social Security strategy

Key Points
  • A nine-year bull market has inspired some retirees to take Social Security benefits early in order to invest that money in the market.
  • Claiming before your full retirement age will result in a reduced payment. Waiting beyond your full retirement age will let your benefits grow by up to 8 percent per year.
  • Weigh the potential downsides of not getting a guaranteed income increase.
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A prolonged bull market has prompted some retirees to rely on one Social Security strategy: Claim benefits early and invest the money.

But use that strategy at your own risk.

Though most prognosticators do not think recent volatility signals an end to the nine-year bull market, the wild swings are likely here to stay.

And a full-on downturn is always a possibility.

"I don't know when or how large it will be, but there's always going to be a bear market and correction in the future," said Aaron E. Graham, a financial planner at Abacus Planning Group in Columbia, South Carolina.

If you think you can do better than [8 percent], I think you should be a hedge fund manager.
Thomas Yorke
Oceanic Capital Management

While you can claim Social Security retirement benefits starting from age 62, your benefits will be larger if you wait.

You receive 100 percent of your retirement benefit if you claim at full retirement age — 66 or 67 for most individuals, depending on when you were born.

If you claim earlier than your full retirement age, you will receive a reduced benefit.

If you wait past full retirement age, your benefit will grow by as much as 8 percent per year up to age 70.

That is one key reason financial advisors caution against taking Social Security early to invest in the market.

"The longer the time span is, the greater the chances you have to be wrong," Graham said.

It's hard to consistently beat an 8 percent return

Consistently getting a return of 8 percent — the top rate by which your benefits can potentially increase if you wait to claim — will pose a challenge for any investor, said financial advisor Thomas H. Yorke, managing director at Oceanic Capital Management in Red Bank, New Jersey.

"If you think you can do better than that, I think you should be a hedge fund manager," Yorke said. "Not only on a risk-adjusted basis you'll likely be way underperforming, but we're just humans and we're subject to all these biases."

While you may be able to beat that 8 percent return a few years in a row, you could run into another year like 2008, Yorke said.

And the closer that sharp downturn is to retirement, the harder it is to make up. If there's a 50 percent pullback in the market, for example, you may need a 100 percent return to get you back to where you need to be, Yorke said.

Tapping Social Security benefits early

Age at claiming Reduction to benefit Monthly benefit after reduction for claiming early Change from delaying claiming by one year
6230 percent$700 --
6325 percent$750 7.1 percent
6420 percent$800 6.7 percent
6513.3 percent$867 8.4 percent
666.7 percent$933 7.6 percent
67 (full retirement age if born after 1960)--$1,000 7.2 percent

Source: Source: Pew Charitable Trusts

Your spouse could get less money

Taking Social Security retirement benefits at 62 only makes sense in a limited number of circumstances, such as if you are single and terminally ill.

But if you are married and are not expecting to live a long time, taking benefits early could reduce the survivor benefits your spouse receives.

A widow or widower is eligible to start receiving reduced benefits on your record as early as age 60 and full benefits at their full retirement age.

In addition, children under 18 or who are disabled may receive 75 percent of your benefit. A widower or widower who is caring for a child under 16 may also receive benefits.

By delaying your payments, you are also increasing the survivor benefits your family may receive. That is particularly relevant if your spouse earns less than you do, said Brett D. Horowitz, a wealth manager at Evensky & Katz/Foldes Financial in Coral Gables, Florida.

"Ultimately, they could be taking money out of everyone else's pockets if they collect early," Horowitz said.

Optimize your Social Security benefits
Optimize your Social Security benefits

Taxes could further reduce your amount

Whenever you receive Social Security, up to 85 percent of it could be subject to federal income tax depending on your modified adjusted gross income, or MAGI.

Regardless of when you take your retirement benefits, you are subject to those tax thresholds.

If you do claim early, those extra years will also be subject to taxation, said Ronald L. Myers, managing member at Fortune 360 Group in Plantation, Florida.

While you are eligible to receive 75 percent of your retirement benefits at age 62, that could be reduced to as little as 50 percent depending on your tax bracket, Myers said.

"When you're comparing it, you have to look at the net number," Myers said.

You will have to make up for the lost income

If you do claim Social Security benefits early, chances are you will take money from another source to make up for that lost income, Myers said.

And if you live to 90 or 95, you could leave tens of thousands or hundreds of thousands of dollars on the table, he said.

For those reasons, Myers said he always encourages clients to wait to claim their retirement benefits.

"That's a decision you can't unwind," Myers said. "By the time people digest it, it's too late."

When you do realize you have made a mistake, your career prospects could be significantly diminished, according to Yorke.

"If at 85 you don't have enough money coming in, you probably won't go out and get a job," Yorke said.

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