The decision you make on when to file for social security benefits may be the most important financial decision you make regarding retirement. In addition, your filing election is permanent. Should you take your benefits early (the earliest being age 62) or late (up to age 70)? What analysis or methodology should you use in analyzing your decision?
Many people race in to take their benefits early without doing any analysis at all but rather for emotional reasons. They feel that "I've paid into this @#$%& system for my entire working life and now I want my money!". What if I die young and never get my money back?
My response to that thinking is twofold. One, it will on average take a person only about 5-6 years to recoup all the money that they have paid in social security taxes over their lifetime. After that, it's all "free money" from the government. Secondly, if you happen to die young before you can recoup your money then, from a financial planning perspective, "all is good". More specifically, you avoided what we consider to be the real risk in retirement which is "the risk of outliving your money" as opposed to the "risk of dying with money".
Another popular method used in analyzing when to take social security benefits is a "break-even analysis". In simple terms, you would try to determine how long it would take you to recoup monies that you could have received early in exchange for taking a larger payout later. Without going into a detailed analysis here, what I have found is that a typical break-even age range is approximately ages 78-80. By that age you will have recouped all the money that you could have obtained by electing benefits early. So, if you think you are likely to live past ages 78-80 then you will get more money by deferring the start of benefits versus filing early.
Finally, some people try to analyze their filing decision by considering how much more money they would get if they took their benefits early and invested that money in the stock market. There are a number of flaws with this analysis the least of which is determining a reasonable rate of return (adjusted for inflation) on your investments.
Ultimately I think all of the various analytical tools we have discussed so far are fundamentally flawed as tools in analyzing when to start taking social security benefits. The reason is that we should not be viewing social security as an "investment" but rather as "insurance". The insurance you get from social security covers the risk of "living too long and outliving your money". This is known as "longevity risk". This risk is real and a growing concern for most retirees.
Virtually all insurance (homeowners, car insurance, term life insurance) are bad "investments" in the sense that you are not statistically likely to recoup the years of premiums that you paid into these policies because the likelihood of you filing for a claim is very small. On the other, you would not go without homeowners insurance, for instance, because if your house burned to the ground that could be a financially catastrophic event. Similarly, I would suggest that the risk of outliving your money would also be a financially catastrophic event that you would want to insure against.
Social security not only provides "longevity insurance", this "policy" also comes with a myriad of "policy riders" including inflation protection, creditor protection (Federally guaranteed), spousal protection, survivor protection, divorce protection, child care and child-in-care protection, disability protection and more...and it's cheap! Where else could you go to obtain such a policy? How much would a policy with all those features and benefits cost you? Could you even find such a policy?
Social Security: A good "investment"? I think so. An outstanding "insurance policy"? Definitely!
Ash Ahluwalia, NSSA, CCSCA, MBA