Should an early retiree take Social Security at 62?

Henry K. Hebeler

7/14/09

People who retire at or before 62 should ask themselves whether they really want to start taking Social Security payments at age 62. Delaying the start significantly increases payments which are often very important later in retirement. My wife and I help a number of impoverished ladies in their eighties who would give their eye teeth for larger Social Security checks, their only income. They regret having made poor financial conditions when they were young, that is, when they were in their sixties.

Benefits of delaying Social Security for a single person:

A single person has a lot fewer considerations than people who are married. Let’s look at an example case of a lady named “Single.” The most important factor is whether Single has a reasonable chance of living past 80. If death is certain to be earlier, then by all means starting Social Security early will be the best choice.

However, if there is a reasonable chance of living past eighty, then the next thing to consider is whether Single has saved enough for support until Social Security starts at a later age. Single doesn’t need a computer to get a rough idea of the savings required. All she has to do is multiply the Social Security annual payments at 66 times the number of years she will delay the start. This assumes she can invest at an after-tax return greater than inflation. The average baby boomer who retires before age 62 does not have enough savings right now to delay till 66, much less age 70.

Example: The annual Social Security Administration report says she will get $1,000 a month at age 62. That’s $12,000 a year. Waiting to start till age 66 is four years, so the very least she has to have saved is four times the age 66 Social Security or $64,000 to consider starting Social Security at 66. Actual savings should be more because Single will need money for emergency and replacement reserves as well as possible investment losses. If she has a pension, the savings could be somewhat less.

Let’s look at a case where Single also has $300,000 in an IRA at age 62. It’s invested in mutual funds that have a before-tax return of 5% after costs and reverse dollar-cost-averaging. (Although dollar-cost-averaging helps people before retiring, it hurts them after retiring.) Further assume future inflation at 4% and tax rates of 15% and Social Security increases at only 3.5%. The results are illustrated in Figure 1. Retirement spending of $23,000 is the same in all three cases. After investments are exhausted, Single will still get Social Security.

Figure 1. Remaining investment balances for Single.

If Single starts Social Security at age 62, she would use her saving up at age 86 and have only $12,000 a year Social Security thereafter. If Single delays the start of Social Security till 66, she will be able to support her spending until she is 90 and have over $16,000 a year Social Security if she lives to be older than 89. (Both Social Security values are in today’s dollars.)

In the case of a single person, it may not pay to delay the start of Social Security until age 70. That would be the case if initial savings were insufficient to support the eight year delay in starting Social Security with a comfortable margin, say significantly over eight years times a $21,000 benefit, or $168,000. However, those who have sufficient savings would do much better. In the case that is illustrated, Single doesn’t exhaust her savings and would continue to be able to spend $23,000 a year past 100.

Delaying Social Security to 70 has certain hazards if savings turn out to be marginal. Single could immediately lock in the Social Security value at whatever age that happened but would be left with little to cope with emergencies and could be forced to buy large ticket items on time rather than with cash. On the other hand, if savings are not marginal, there can be huge benefits from waiting till age 70.

Starting Social Security at 62, paying back the benefits, and restarting at 66:

What if Single wants to plan on starting Social Security at 62 and take advantage of the ability to return gross Social Security payments to the government and restart Social Security at age 66? Few people know that you can do this without paying the government any interest charges, and there is no penalty. Figure 2 illustrates what happens in this case. This may be the best thing to do for someone who started Social Security too early and now recognizes it was a mistake.

It’s usually better to simply delay the start of Social Security rather than plan on payback after starting Social Security at 62 for a number of reasons. You have to pay back the gross amount of accumulated Social Security, not the sum of your actual Social Security payments. That means you cannot invest all of the Social Security receipts if you are taxed on the amount. (This is obvious if you choose to have tax withheld.) Another deduction is for Part B and D of Medicare that starts after 65. There is also the problem of recouping the taxes paid on Social Security receipts. The only way to get the full amount of a tax credit is to resubmit your 1040 forms for all of those years. Ugh! There are more problems if forced to go back to work at wages requiring reductions in Social Security payments. Of course, the Social Security Administration could change the rules as well, as could the IRS, leaving you trapped at the 62 values.

The capability to investigate paying back Social Security is part of the free Social Security program from www.analyzenow.com. It also has the capability of showing the effects of Medicare Part B deductions which can make an important difference in results.

Figure 2. Starting Social Security at 62 but paying it back at 66 helps rectify having started too early.

Benefits of delaying Social Security for a married couple:

Delaying the start of Social Security till age 70 may be the best choice for the high-earning spouse in a marriage while the low-earning spouse starts at age 66. Let’s illustrate this with an example for Mr. and Mrs. Married. Mrs. Married is two years younger than Mr. Married, and Mrs. Married is a low-income spouse. Their Social Security payments are shown in Figure 3. Mrs. Married is able to take advantage of the Social Security earned by Mr. Married because of the very favorable Social Security rules for low-income spouses. That’s especially important if Mr. Married dies before his spouse. In the example below, Mr. Married dies at age 85. If you consider the effects of inflation, the payments in today’s dollars reduce with age when inflation is greater than the Social Security adjustments as in Figure 3. But it’s also true in real life because medical costs become an ever increasing component for the elderly.

Figure 3. Annual Social Security payments in today’s dollars for Mr. and Mrs. Married.

Figure 4 displays the history of their investment balances. The retirement spending is the same in all three cases. Note that as long as Mrs. Married lives into her eighties, if she had started Social Security at 70 she is going to have a lot more investments left than in either of the other two cases. However, note that Mr. and Mrs. Married have used up most of their savings in this case before age 70. They could be locked into their age 62 Social Security should their investments fall or they need a large sum for an emergency.

Figure 4. After-tax investment balances for Mr. and Mrs. Married. In the case for the 70 Start, the high-income spouse delays Social Security till 70 while the low-income spouse starts at 66.

Once Mrs. Married gets into her eighties, not only does Mrs. Marriage have a better stash of investments for the rest of her life had she delayed Social Security till 70, she has much higher Social Security income should some emergency exhaust her investments.

Restarting Social Security for either spouse in a marriage:

The benefits of starting Social Security at 62 and restarting at a later age are highly dependent on the individual ages of the spouses as well as the amounts that each will get at age 62. The best way to determine the best alternative is to run a computer simulation for each alternative and then compare the results. You can do this with the Pre and Post Retirement Planner program from www.analyzenow.com. It has two separate programs running simultaneously and displays results from both alternatives on the same charts.

I believe that it is not a good strategy to plan on starting Social Security at 62, and then repay Social Security and restart at an older age. This can really get complex for a married couple not only for the same reasons as for Single above, but also because payback will require the spouse to payback as well if spousal benefits were involved.

Complexities:

Many of the local Social Security Administration employees are not familiar with the payback provisions, and some try to discourage the use of repayment, perhaps because of the extra work on their part. The paperwork considerations for the Social Security recipients are the application, possible Medicare details and recovering income tax that was paid on Social Security benefits.

To repay Social Security, you can download Form 521 from www.ssa.gov for your submittal to the Social Security Administration.

The Medicare payment considerations don’t come into play if you repay before 65 but can pose some difficulties if you don’t follow the rules on http://www.ssa.gov/retire2/withdrawal.htm.

Those people who have incomes high enough so that their previous Social Security payments were taxed can recover the tax either by claiming a deduction on Schedule A of the 1040 form or by recalculating the tax on each of the previous years and resubmitting those returns. Use whichever gives the greatest benefit. You can find more information on this in IRA Publication 915, p. 15, “Repayments More Than Gross Benefits.”

Conclusions:

The best age to start Social Security for a single person taking early retirement may be age 66, not 62, providing that the initial savings are sufficient and that the retiree expects to live past age 80. On the other hand, the best ages for a married couple may be when the low-income spouse to starts at 66 and the high income spouse starts at age 70. These results are dependent largely on the initial savings, respective ages of the spouses, and death ages. It’s legal to restart Social Security at a later age and gain significant benefits, but this is dependent on future regulations and laws being the same as today’s.

Note: All of the figures come from free programs on www.analyzenow.com.