Should You Take Social Security Early and Invest It?

As you approach retirement age, one of the most significant decisions you'll face is when to start claiming your Social Security benefits. It's a choice that can have lasting impacts on your financial well-being throughout your golden years. Many retirees wonder, "Why can't I take Social Security early and invest it?" It's an intriguing question that deserves a thorough exploration.

In this article we'll dive deep into the pros and cons of claiming Social Security early and investing the benefits. We'll examine the math behind this strategy, consider various investment scenarios, and discuss the crucial factors you need to weigh before making this important decision.

KEY TAKEAWAYS

• Claiming Social Security early and investing can potentially lead to higher total benefits, but it comes with significant risks.
• When comparing strategies, it's crucial to consider risk-adjusted returns, not just potential upside.
• The guaranteed increase in benefits from delaying Social Security is a risk-free return that's hard to beat consistently in the market.
• Consider factors beyond just the math, including spousal benefits, your overall financial situation, and your risk tolerance.
• For most retirees, delaying Social Security (if possible) is likely to be the safer and often more beneficial strategy.
• If you're considering claiming early and investing, consult with a financial advisor who can help you understand all the implications for your specific situation.

UNDERSTANDING SOCIAL SECURITY BASICS

I cannot overstate the importance of grasping the fundamentals of Social Security. It's more than just a government program; it's a cornerstone of your retirement income strategy. Making informed decisions about Social Security can significantly impact your financial well-being in your retirement years.

Before we delve into specific investment strategies, let's refresh our understanding of how Social Security works and how it fits into your overall retirement plan.

What is Full Retirement Age (FRA)?

Your Full Retirement Age (FRA) is a pivotal milestone in retirement planning. It's the age at which you're eligible to receive 100% of your calculated Social Security benefits based on your earnings record.

Understanding your FRA is crucial because it affects not only the amount you'll receive but also the strategies you might employ to maximize your benefits.

• Birth Years 1943–1954: FRA is 66.
• Birth Years 1955–1959: FRA gradually increases by two months each year. For example, if you were born in 1955, your FRA is 66 and 2 months.
• Birth Year 1960 or Later: FRA is 67.

Early vs. Delayed Claiming

You can start claiming Social Security as early as age 62, but your benefits will be permanently reduced. On the flip side, if you delay claiming beyond your FRA (up to age 70), you'll receive increased benefits.

Here's a breakdown of how your benefits change based on when you claim:

Note: This table assumes an FRA of 67. Percentages may vary slightly for those with different FRAs.

THE CASE FOR TAKING SOCIAL SECURITY EARLY AND INVESTING

Now, let's explore the argument for claiming Social Security early and investing the benefits. The core idea is simple: by taking the money earlier and investing it wisely, you might end up with more wealth in the long run compared to waiting for higher monthly payments later.

The Power of Compound Interest

The cornerstone of this strategy lies in the power of compound interest, a fundamental principle of investing where the interest you earn on your investment also earns interest over time. This exponential growth can significantly amplify your wealth, especially over longer periods.

Early Investment Timeline: By claiming Social Security benefits early, you gain immediate access to funds that can be invested. The earlier you start investing, the more time your money has to compound and grow.

Example Scenario: Suppose you begin receiving a monthly benefit of $1,500 at age 62 and invest it with an average annual return of 6%. By age 70, your investment could grow to approximately $174,000. In contrast, delaying benefits until age 70 would increase your monthly benefit but forgo these years of potential investment growth.

Small Differences, Big Impact: Even slight variations in your investment timeline can lead to substantial differences in wealth accumulation. Over decades, the effects of compounding can significantly outpace the incremental increases from delayed Social Security benefits.

Potential for Higher Returns

Historically, investing in the stock market has offered higher returns compared to the guaranteed increase in Social Security benefits for delaying your claim.

Social Security Delay Credits: For each year you delay claiming past your Full Retirement Age (up to age 70), your benefits increase by approximately 8% per year.

Historical Market Returns: The average annual return of the S&P 500 over the past several decades has been around 10% before adjusting for inflation. Even with a conservative approach, achieving a 6-7% return is plausible.

Risk and Reward Balance: While the market offers the potential for higher returns, it also comes with risks. However, with a well-diversified portfolio and a sound investment strategy, you might outperform the guaranteed 8% annual increase from Social Security delays.

Control Over Your Money

By taking Social Security benefits early and investing them, you gain greater control over your finances. You can tailor your investment strategy to match your risk tolerance and goals, choosing between aggressive growth or conservative income. Invested funds are liquid and accessible for unexpected needs or opportunities.

Moreover, if you pass away, the invested money remains part of your estate and can be passed on to your heirs, potentially continuing to grow and provide a lasting legacy. In contrast, delayed Social Security benefits generally cease upon your death, which might result in less total value for you and your family.

CRUNCHING THE NUMBERS: WHEN DOES EARLY CLAIMING AND INVESTING MAKE SENSE?

To understand when this strategy might work, let's look at some scenarios using different investment returns.

Scenario 1: Investing in a High-Yield Savings Account

Let's start with a conservative scenario. Imagine you could invest your early Social Security benefits in a high-yield savings account earning 4.7% annually (based on the average overnight Federal Funds rate since 1960).

In this case, claiming early only makes sense if you expect to pass away by age 77 or earlier. Otherwise, waiting until your Full Retirement Age or later is likely to be more beneficial.

Scenario 2: Investing in a 60/40 Portfolio

Now, let's consider a more aggressive investment strategy. A traditional 60/40 portfolio (60% stocks, 40% bonds) has historically returned about 9.3% annually since 1950.

With these returns, claiming Social Security at 62 and investing the benefits could be advantageous for anyone who expects to live until age 88 or less. This is a significant shift from the previous scenario and might seem very appealing at first glance.

THE CRITICAL FACTOR MANY OVERLOOK: RISK

While the idea of claiming Social Security benefits early and investing them may seem attractive due to the potential for higher returns, it's essential to consider a critical factor that many overlook: risk.

Understanding the risks involved is paramount to making an informed decision that safeguards your long-term financial security.

Guaranteed Benefits vs. Market Volatility

When you delay claiming Social Security, your increased benefits are guaranteed by the U.S. government. This is essentially a risk-free return on your "investment" of delayed claiming.

In contrast, investing in the market – even with a diversified portfolio – comes with inherent risks. The stock market can be volatile, and there's always the possibility of significant losses, especially in the short term.

Sequence of Returns Risk

One of the biggest dangers for retirees who invest their savings is sequence of returns risk. This refers to the risk of experiencing poor investment returns in the early years of retirement, which can have a devastating impact on your long-term financial security.

If you claim Social Security early and invest it, only to face a market downturn in the first few years, you could end up significantly worse off than if you had waited to claim.

A MORE REALISTIC COMPARISON: RISK-ADJUSTED RETURNS

To make a fair comparison between claiming early and investing versus delaying benefits, we need to consider risk-adjusted returns. There are two main approaches we can take:

1. Comparing to a Risk-Free Rate

One approach is to compare the guaranteed increase in Social Security benefits to a truly risk-free investment rate, such as short-term U.S. Treasury bonds or an FDIC-insured high-yield savings account.

When we make this comparison, we find that the results align closely with traditional Social Security advice: for most people, it makes sense to delay claiming unless you have reason to believe you'll have a shorter-than-average life expectancy.

2. Considering Worst-Case Scenarios

Another approach is to look at potential downside scenarios for more aggressive investments. For instance, while a 60/40 portfolio has averaged 9.3% annual returns historically, it has also experienced 10-year periods with returns below 2% per year.

If we model a scenario where early claiming and investing coincides with a period of poor market performance, we find that this strategy only works out if the retiree passes away before age 75 – a much less favorable outcome than initially appeared.

THE SPOUSAL FACTOR: AN IMPORTANT CONSIDERATION

When deciding whether to claim Social Security early and invest, it's crucial to consider the impact on spousal benefits. If you're married, your claiming decision doesn't just affect you – it can significantly impact your spouse's financial security as well.

Survivor Benefits

If you're the higher earner in your marriage, delaying Social Security can provide your spouse with a higher survivor benefit if you pass away first. This is an important form of insurance that shouldn't be overlooked.

Spousal Benefits

For couples where one spouse has significantly lower lifetime earnings, the lower-earning spouse may be eligible for spousal benefits based on the higher earner's record. The timing of when the higher earner claims can impact these spousal benefits.

OTHER FACTORS TO CONSIDER

While the math and risk considerations are important, there are other factors you should weigh when deciding whether to claim Social Security early and invest:

• Your overall financial situation: If Social Security is a crucial part of your retirement income, taking it early and investing it might be too risky.
• Your health and family history: If you have reason to believe you may have a shorter life expectancy, claiming early could make more sense.
• Your risk tolerance: Be honest with yourself about how comfortable you are with investment risk, especially in retirement.
• Your other sources of income: If you have substantial savings or pension income, you might be better positioned to delay Social Security.
• Your desire to leave a legacy: If leaving money to heirs is a priority, claiming early and investing might align with your goals.
• Tax implications: Remember that Social Security benefits can be taxable, and investment gains are typically taxed as well. Consider how your strategy might impact your overall tax situation.

WHEN MIGHT CLAIMING EARLY AND INVESTING MAKE SENSE?

While for most people, delaying Social Security is likely to be the better option, there are scenarios where claiming early and investing could be worth considering:

• If you have a strong reason to believe you'll have a shorter-than-average life expectancy
• If you have substantial other retirement savings and Social Security is "extra" money for you
• If you're comfortable with investment risk and have a solid understanding of market dynamics
• If you have a specific investment opportunity that you believe will significantly outperform the guaranteed return from delaying Social Security

CONCLUSION

While the idea of claiming Social Security early and investing it can seem appealing, it's important to approach this strategy with caution. For most retirees, the guaranteed increase in benefits from delaying Social Security is likely to be the safer and more beneficial choice.

Remember, Social Security was designed to provide a guaranteed income floor for retirees. By claiming early and investing, you're essentially converting a portion of that guaranteed income into a riskier asset. Make sure you fully understand and are comfortable with the trade-offs before pursuing this strategy.

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