Why You Should Think of Social Security Like You Think of Tax Refunds

Two Social Security cards rest on top of several $100 bills.
DNY59 / Getty Images/iStockphoto

Millions of Americans look forward to tax refunds every year, and when the money comes, they treat it like they won a scratch-off or got a bonus at work.

But your refund isn’t a gift from the IRS. It’s repayment for an involuntary, interest-free loan you extended the government when your employer withheld too much tax money from your paychecks on your behalf.

Instead of celebrating the refund, you should be angry that you didn’t have access to those hard-earned dollars all year long. If you had, that money could have been earning compound interest in a savings account, returning gains and dividends in a stock fund or appreciating in a real estate investment.

A similar shift in psychology might enrich Social Security recipients, who have long been told to maximize their monthly checks by waiting as long as possible to claim benefits. Here’s how.

Hold Out as Long as You Can for Full Benefits and Credits, Right?

Your birthday determines your full retirement age, which is 67 for most people. You can claim Social Security as young as 62, but the SSA docks you five-ninths of 1% for every month you retire early up to 36 months. Beyond that, you lose another five-twelfths of 1% per month.

If you claim early by the full 60 months between 62 and 67, you’ll lose 30% of your benefit — what would have been a $1,000 monthly check is now only $700.

Are You Retirement Ready?

On the other hand, if you wait beyond your full retirement age, you get two-thirds of 1% extra per month — or 8% per year — up to age 70 in the form of delayed retirement credits.

The difference between 70% of your full benefit on the low end and 124% on the high end has created a nearly universal consensus that it’s best to wait as long as you can to get the biggest check possible. After all, on a hypothetical $1,000 benefit, $1,240 a month is a whole lot better than $700.

“It is best to delay Social Security to earn a guaranteed income in retirement,” said Steve Parr, owner of Parr Business Law. “By delaying Social Security, a person can acquire the maximum benefits over time. In addition, you will be able to access delayed retirement credits.”

But that line of thinking ignores the powerful force on the other side of the big Social Security tradeoff — time.

Bigger Checks vs. More Time: The Break-Even Point

No one would trade $1,240 for $700, but the SSA only gives raises in exchange for time. There are eight years between 62 and 70, and you have to settle for $0 every month for 96 months to turn $700 into $1,240.

Because of the bigger monthly check, the 70-year-old will eventually catch up to the 62-year-old, but it takes a long time, which is something 70-year-olds don’t have.

It’s called the break-even point. That’s when your cumulative benefits from retiring later match and exceed the cumulative benefits you would have received from retiring earlier.

Are You Retirement Ready?

Presuming a $1,000 monthly benefit and a full retirement age of 67, here’s how long it would take delayed retirees to break even with someone who had been collecting smaller checks since 62.

  • If you wait until 65, you won’t break even until a little after 77 1/2.
  • If you wait until 67, you won’t break even until a little before 80 1/2.
  • If you wait until 70, you won’t break even until 82 1/2.

Like Tax Refunds, Your Money Can’t Work for You While the Government Is Holding It

Just like your tax refund is money the government denied you the opportunity to invest, postponing Social Security steals time you could have spent growing your benefit to match or exceed the delayed retirement credits you would have earned by waiting.

“Let’s consider an anecdote where an investor claims Social Security at 62 and diligently channels these funds into well-researched, high-yield real estate opportunities,” said Dennis Shirshikov, professor of finance, economics and accounting at the City University of New York and the head of growth at real estate investing site Awning. “The cash flow from such investments, especially if they’re astutely managed and in a climbing market, could conceivably outpace the forgone benefits from delaying Social Security. Moreover, this strategy could offer the added advantage of diversifying one’s income streams, providing a cushion against the volatility inherent in relying solely on market-linked investments.”

If You Don’t Need To Spend It, Start Saving It at 62

If you’re not relying on Social Security to finance your daily life, claiming your benefits at 62 can leave you with more money in the long run than you would have gotten by waiting for a bigger check.

Are You Retirement Ready?

That’s because the break-even point deals only with the dollar amount the SSA pays you each month at a given age. It does not consider how that money might have compounded over the same period if you had access to it all along — just like your tax refund.

For example, your benefit loses 30% of its value between 67 and 62, which — for the sake of simplification — is an annualized penalty of 6%. It’s certainly possible to earn 6% returns as an investor. But even if you kept the money in an FDIC-insured savings account earning 3% interest, your $700 monthly contribution starting at 62 would grow to $76,744.35 by age 70 — $67,200 in contributions and $8,844.35 in interest.

That alone is enough to push the break-even point far beyond the limits of even an above-average lifespan — the person who held out until 70 for the maximum benefit would almost certainly never catch up.

In short, a smaller monthly check and more years is better than a bigger monthly check and fewer years — but only if you don’t need to spend it.

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