Personal Finance

Deciding when to claim Social Security based on break-even calculations? Be careful

Key Points
  • When it comes to claiming Social Security retirement benefits, most experts will tell you not to start your checks at age 62. Instead to let your benefits grow.
  • Many individuals have a hard time taking that advice. Their argument: Putting off those earned benefits will result in a longer time to reach breakeven, when you will have received the same amount as if you claimed early.
  • Experts warn that calculating breakeven is tricky. To do it right, be realistic about how much you could earn by investing your benefits and how much your benefits will increase each year.

It's a debate that typically comes up when discussing whether to delay Social Security benefits: Will that result in less total money over your lifetime?

The longer you wait on those retirement checks — up until age 70 — the larger the monthly payments you'll receive.

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That's why experts generally advise you to hold off, unless personal circumstances, such as health or marital status, make it more advantageous to claim earlier.

Yet critics point out that waiting will prolong how much time it takes to reach "breakeven," or the point at which the amount you receive if you claim later equals the amount you would have received if you had started early.

The age at which you will break even generally ranges from 77 to 83, depending on when you started receiving benefits.

Social Security is designed with "actuarial neutrality" in mind. That is, regardless if you start receiving your benefits earlier or later, you should receive about the same total money over your lifetime.

Calculating your individual breakeven can be done by charting the cash you would receive when you claim early versus the cash you would receive if you delay, according to Joe Elsasser, president of Covisum, a provider of Social Security timing software.

However,  some blind spots can create misleading results and lead you astray.

Benefits provide a guaranteed return

When calculating your break-even point, you need to account for what you could have earned if you had taken the money earlier and invested it, Elsasser said.

While that can be difficult to tally on your own, professional software and some consumer calculators can help.

For every year you delay your benefits from your full retirement age (generally 66 or 67, depending on the year in which you were born) until age 70, your benefits increase by 8% — a return that is hard to beat elsewhere.

When you're weighing how investments factor into your decision, don't forget the value of Social Security benefits relative to riskier asset classes.

"You're never going to have a Social Security benefit that loses 40% in a market crash," Elsasser said.

Social Security myths
Social Security myths

Many people make the mistake of comparing Social Security benefits to the average return of the Standard & Poor's 500, according to Doug Lemons, a Social Security expert and certified financial planner.

"You really shouldn't be using that kind of rate of return for Social Security benefits," Lemons said. "The risk of Social Security benefits is much less. It's backed by the full faith and credit of the United States government, whereas the S&P has a very high risk compared to that."

Instead, try comparing your Social Security benefits to Treasury Inflation-Protected Securities, Lemons said. Like Social Security benefits, TIPS are fully inflation protected and backed by the full faith and credit of the U.S. government.

Also keep in mind that if you claim Social Security early and continue to work, your benefits could be reduced or taxed at a higher rate, said John Piershale, financial advisor at Clarity Group Midwest.

By delaying benefits, you not only avoid those taxes but also allow your individual benefit to grow.

Benefit increases are not guaranteed

Every year, the Social Security Administration adjusts its benefits to keep up with inflation. In 2019, benefits increased by 2.8%.

The adjustment varies annually, and some years had no increases. The median expected cost-of-living adjustment over time is 2.6%, according to Elsasser.

If you include those increases in your calculations, you're going to get larger numbers that look more impressive, Elsasser said.

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"That's going to slant the calculation and the break-even age to make it look as though delaying is more beneficial quicker," Elsasser said.

The solution: Do not include those increases in your calculations.

"If you're going to do a break-even analysis on your own, do not include cost-of-living adjustments," Elsasser said. "If someone else is doing a break-even analysis for you, be mindful that those numbers look big, and that's why a lot of people use them."

Don't forget to include your spouse

You should be extra careful with break-even calculations if you're married.

"For a married couple, thinking in terms of break-even age is actually dangerous," Elsasser said.

Someone who is married and looking at the breakeven is saying, "I think I should claim early because I'm not sure that I have a long enough life expectancy to cross my breakeven age," according to Elsasser.

"There is a lot of I's and my's in that statement, which means there's no concern for the impact of my decision on my spouse," Elsasser said.

How to plan around these outdated Social Security benefits
Social Security benefits are outdated. Plan around them.

If you're married, your spouse should be a big consideration in your claiming decision. That is because starting benefits earlier can also reduce your spouse's benefits if they plan to claim on your work record.

How long you and your spouse expect to live should also be weighed when deciding on a strategy.

"I would not leave it to guesswork," Piershale said. "It's just not that easy to figure out by being intuitive. You should really put the pencil to the paper and just run some numbers."