Most people have heard the often used quote, “There is no free lunch”. The unknown origins of the phrase began almost a century ago; however, it only began to be commonly used during the 1960s and 1970s when the Nobel Prize winning economist Milton Friedman used the term in his book of the same title, and another famous science fiction author did the same thing.
I definitely agree with the idea behind this quote, especially in personal finances. It is hard to argue that you can receive something of value for nothing or without offering something else back in return. However, as with many principles and guidelines in life, there can be exceptions, even when it comes to books written by a Nobel economist.
But not to worry – today’s article is not about a got rich quick scheme or some other questionable financial gimmick! It is actually about Social Security and how you can strategically use your benefit elections to potentially help your long-term financial picture, obtain a much higher level of benefits and increase the odds of attaining a confident retirement.
That’s right! This important cornerstone of our taxpayer funded retirement system can actually do more than replace some of your income when you eventually stop working. A thoughtfully crafted “claiming” strategy for your Social Security benefits has the potential to materially enhance your long-term financial situation and reduce “longevity risk”.
How Social Security Works
To understand why there may be a free lunch in Social Security, let’s first explore how the system works. As many are aware, you can begin claiming Social Security benefits at age 62, as late as age 70 (there is no benefit to you in waiting longer), or at some age between 62 and 70.
However, if you claim benefits before your “Full Retirement Age” (between age 66 and 67 depending on you birth date), each benefit check will be 25% to 30% less than it would have been had you waited and claimed your benefit at full retirement age.
Alternatively, if you postpone filing for benefits past your full retirement age, you’ll earn delayed retirement credits for each month you wait, up until age 70. Delayed retirement credits will increase the amount you receive by about 8% per year if you were born in 1943 or later.
In addition, inflation is a positive integrator when it comes to Social Security benefits. With a rise in other prices, your Social Security benefits will begin to increase beginning at age 62, even if you have not yet claimed benefits. The increased benefits that come with inflation are over and above the 8% that you get if you delay claiming Social Security!
Where’s The “Social Security” Free Lunch?
These inner workings of your Social Security benefits indicate that waiting to claim might likely be advantageous. In my opinion, this is the “free lunch” part of Social Security. The decision to wait has very significant potential to provide a higher level of benefits during your lifetime, which means that other portions of your retirement savings will not need to work as hard after you stop working.
Before I imply that the decision to delay claiming is an “open and shut” case, it is important to acknowledge the trade-offs. For example, by not claiming at age 62 (the earliest age possible), you would be temporarily not receiving the payment of benefits at a younger age.
However, the higher payments that you will receive by waiting to claim at your Full Retirement Age (or later) may likely more than compensate you for a decision to delay benefits. This is almost always going to be true if you have an average life span.
Advancements in the state of medicine and technology over the past few decades, and the likelihood that these innovations may continue, make the case for claiming no earlier than your Full Retirement age a compelling option. The implications of medical and technology innovations means that it is likely that many of us will have an average lifespan, if not longer.
Reduce the Risk of Outliving Your Retirement Savings
From a financial standpoint, a longer life expectancy further increases one of the key long-term planning risks for mid-life professionals, which is “longevity risk.” This refers to the possibility that you may outlive your financial assets.
As I wrote in a recent blog post on this subject, underestimating your longevity might be a risky financial move if you have an overly pessimistic view of your life expectancy or if you live longer than you expect.
This is really at the core of why I think you can get a “free lunch” from the Social Security program. If you think there is any possibility that you will live into your early or mid-80s (or beyond), as life expectancy tables for those in their 60s would suggest, delayed claim has the potential to materially help your long-term finances and reduce longevity risk.
Will Early Retirement Leave Your Free Lunch on the Table?
What should you do if you expect to stop working at age 62? In my opinion, it still might likely make sense to delay starting your benefits until at least your Full Retirement Age, if not even later. This choice could mean that you might temporarily need to make somewhat larger withdrawals from your savings and/or retirement accounts while you wait to claim Social Security.
In my opinion, that choice is nevertheless often better than starting Social Security before your Full Retirement Age and as a way to reduce your savings withdrawals. Starting those benefits early means you will receive a much lower level of benefits over the rest of your life.
The choice to claim early retirement would only be financially advantageous if you think you can consistently earn an average return of at least 8% to 10% annually, or if you were certain that your lifespan would be much shorter than average.
Although these attractive investment returns are not impossible to attain over the long-term, they are certainly not guaranteed, unlike Social Security. Assuming such a high level of long-term investment returns is a “bet” or planning assumption that I encourage my clients and others NOT to make. This is not because I am a pessimist, but because it introduces a level of uncertainty and risk that may not be prudent.
Your Personal Situation Should Drive Your Decision
There are certainly situations when it may not be advantageous to claim these benefits at your Full Retirement Age or later. If you absolutely need the money right away or if there is a certainty that your longevity may be much shorter than average, your decision may understandably be different.
Regardless of your actual choice, I think it is very important to make an informed and well-reasoned decision based on your personal circumstances. You should consider your total financial picture such as how much retirement income you will need, your life expectancy, how your spouse or survivors might be affected, whether you plan to work after you start receiving benefits, and how your income taxes might be affected.
Frequently, my office helps people evaluate these decisions in a logical and objective fashion. The choices are also even more complicated for married couples, single people who are divorced, and for widowers.
Please feel free to contact me if you have questions about such claiming decisions. For mid-life professionals in transition and thinking about their financial future, this is one subject you need to understand, even if it may be several years before you stop working.
Plan Now to Increase the Chances of a Winning Strategy
Understanding your claiming options and potential benefits is an important part of determining how much money you will need to set aside once you eventually leave the workforce.
Even though your choice may be years away, considering these potential moves down the road can help clarify your savings and investment goals. This can be particularly useful when you are in a time of change.
I would never disagree with Milton Friedman or any other Nobel Prize winning economist! There is rarely a “free lunch.” But beginning to consider a thoughtful Social Security claiming strategy has the potential to clarify your long-term financial goals, while increasing the odds of moving successfully toward a confident future.
That is a free lunch I would consider taking any day of the year! Please do not hesitate to contact my office if we can help in any way.
Social Security Facts provided from www.ssa.gov