62 is the earliest you can claim your benefit (reduced), and age 70 is the latest you should claim because that’s the age the benefit is maximized. Your stop working age can be different than your Social Security claim benefits age.
The below article was originally written for an adviser newsletter by Elaine Floyd, CFP®, Director, Retirement and Life Planning, Horsesmouth, LLC . I have edited it [my brackets for some clarifications (italics and some bold points are my emphasis), and links, here and there]. I thank her for permission to share it with you. Enjoy.
Longtime Savvy Social Security Planning member Larry Frank, an advisor in Roseville, California, develops “bridging” strategies for his clients. Regardless of a client’s planned retirement age, in most cases he recommends starting Social Security at age 70 in order to maximize lifetime benefits for clients and surviving spouses. The question then becomes how to generate income before Social Security starts [when you stop working at any age before age 70?].
Larry’s bridging strategy involves setting aside a sum of money to provide income equal to the age-70 benefit starting at retirement. For example, if a client is retiring at 60, and if the age-70 benefit is expected to be $3,559 [from their current SS Statement], he would have the client set aside $3,559 x 120 months=$427,080. This way, the client would start retirement by withdrawing $3,559 each month from the $427,080 pool. By age 70 the pool would be exhausted, and Social Security would kick in in the same amount. (We are ignoring inflation, present value, future value, etc. for these examples. We are also ignoring other assets and any income need over and above the age-70 Social Security benefit). [These numbers in this paragraph are from MY client example to Elaine – NOT the same worker that she assumes below since she’s assuming a maximum earner for her numbers, which is not the case in my example above].
[The main question that generated this comparison.]
Larry’s question to us [Elaine at Horsesmouth] concerned the accuracy of the age-70 benefit estimate. If he [Larry] takes the PIA [Primary Insurance Amount] off the client’s statement—that is, the benefit amount the client will receive if he [client] applies at full retirement age (FRA)—it [Social Security at age 70 estimate] will be overstated because it assumes the client will continue to work until full retirement age. If he stops working at 60, won’t this reduce the PIA [because the client stopped working, which is not what the statement estimate assumes] and, in turn, the age-70 benefit estimate as determined by our Savvy calculators [software from Horsesmouth]? This would cause the bridge amount to be also overstated. The client ends up overspending during the bridge years, only to face a lower Social Security benefit at age 70 when he does claim. Also, the main portfolio will have taken a larger hit over these years due to having set aside a lump sum larger than needed.
To answer Larry’s question I [Elaine] did a few calculations to see exactly how much money we’re talking about. I used an example of someone [maximum earner] who is 58 now (born in 1960) and plans to retire at age 60 (in 2020). Using the SSA Quick Calculator for a maximum earner, his age-62 benefit would be $2,042. (They only show the age-62 benefit because the client is retiring before 62 and they assume he’ll start his SS as soon as possible.) To get the PIA, we divide by .70 (the reduction factor for FRA 67) to get $2,917. Then to get the age-70 benefit, we multiply $2,917 x 1.24 (3 years of DRCs for FRA 67) to get $3,617. This is the amount the client will actually receive if he stops working at 60 and applies for benefits at 70. (Meaning it’s the closest estimate we can get, since these numbers are never exact.) This would suggest a bridge pool of $3,617 x 120=$434,040.
Next, I ran it for a retirement age of 67 [client continued to work until age 67] and got a PIA of $2,975. This is the PIA that would appear on the client’s statement and is the amount Larry would normally enter into our calculators. Using this PIA, the calculator would figure an age-70 benefit of $3,689 ($2,975 x 1.24), or $72 [=3689-3617] more than we got from the Quick Calculator. So the bridge pool calculation would be $3,689 x 120 months=$442,680, or $8,640 [=442680-434040] more than suggested by the Quick Calculator [because they continued working until age 67]. Using these numbers, the client would take withdrawals of $3,689 from age 60 to 70 and then face a $72 drop in income when the Social Security benefit turns out to be $3,617. Not only would this drop in income be disappointing to the client, it would also cause an extra $8,640 to be set aside in the bridge pool that could have been invested with the rest of the portfolio for higher longer-term returns.
Now, it could be argued that in the scheme of things, $72 a month or an $8,000 difference in a bridge pool approaching half a million dollars isn’t a lot of money, especially since we’re dealing with estimates anyway. And Larry acknowledged as much. Still, we try to be as accurate as possible in our estimates.
So I would recommend adjusting the PIA before putting it into our Savvy Calculators. The easiest way to do this is to knock off about $60 from the PIA shown on the statement. The more accurate way to do it would be to have the client run the SSA Retirement Estimator. This will provide a more accurate estimate because it taps into the client’s own earnings history. Have the client put in his expected retirement age and bring up the age-62 benefit. For an FRA of 67, divide that amount by .70 to get his PIA. This is the number you’ll use in our calculators. The calculator will then show the age-70 benefit based on earnings through the client’s actual retirement age if earlier than FRA. Out of the client’s assets you can then set aside a lump sum equal to that age-70 benefit times the number of months between retirement and age 70.
[Moral of the story so far: Indeed, there is a small error between the bridge amount and the actual benefit when one does reach age 70 (or some other age one wishes to bridge to, say from age 60 to age 67). It was not as large, in terms of today’s dollars, as Elaine and I originally thought. I typically also request my clients continue to get their Social Security statements during their “bridge years” so that we can be more aware of what the age 70 benefit (or other bridge-to-age if earlier than that) may be the closer we get. In other words, reviews provide the ability for slight course corrections along the way.]
Where to put the bridge money
Larry ignores inflation adjustments and keeps everything [stated] in today’s dollars. I agree with this approach because inflation will mostly take care of itself. If the Social Security benefit is rising with inflation, and if the set-aside fund is keeping up with inflation, everything will rise more or less together. Again, we can never get very precise with these numbers.
Larry puts the set-aside in cash and short-term bond funds. Out of curiosity I checked with ImmediateAnnuities.com to see how much monthly income could be generated by a $434,040, 10-year certain annuity [payments made for 10 years ONLY] for a 60-year-old male in the state of California. It came out to $3,906. Noting that this is more than the $3,617 figured for the bridge fund, I went back to Larry to ask why he wouldn’t recommend the annuity. Here’s what he said: “Indeed, that’s an option IF the person/couple wanted to ‘hand over their money’ to an insurance company and lock in the bridge period. I know it’s silly, but that’s the common reaction I get. It seems people like to feel like they have more say in the matter when they can see a balance. Also, life changes and they feel like they can switch gears in the intervening 10 years should life change.” [In other words, why lock in a decision you can still make anytime at a later date?] All valid points. I know that many advisors do use immediate annuities for the bridge income, and they are appropriate for many clients [and I [Larry] have suggested them too in specific situations where that was best – e.g., spendthrifts who wouldn’t be able to resist spending faster than they should]. [Finally, note that the annuity payment is higher than the age 70 benefit estimate so there would be a pay cut in the example above when the annuity ended and Social Security started; or less money ($401,928) may be used to buy the specific monthly amount desired ($3617). Family specifics and desires always come into play].
Need to rethink retirement?
Implied in all of this is the wisdom of starting Social Security at age 70. [my emphasis added] Because claiming at 70 hedges against longevity risk and maximizes lifetime income for the couple and for the surviving spouse, the question of when to claim is taken off the table. [my emphasis added] This means any client who wants to retire before age 70 would need to have enough money to carry them through the bridge period. And it’s easy enough to quantify as we just saw: multiply the projected Social Security income by the number of months between retirement and age 70, and set those funds aside, separate from the rest of the portfolio that will be generating additional income, both now (if needed) and in the future (to keep up with inflation). I have seen some models where the bridge income is based on the age-62 benefit; this would require a lower set-aside, of course. But it would probably require greater withdrawals from the main portfolio to meet the client’s income needs to compensate for that lower age-62 benefit amount. The client’s income need will be whatever it is; the question is where the money will come from to meet it.
Once a client sees how much money he’ll need to set aside to generate income equal to the age-70 Social Security benefit (which is not likely to meet all of his income needs anyway), he may decide to rethink his retirement date. Nothing wrong with that. If I may state the obvious: it is better to find out now if there are insufficient funds to stretch throughout the desired retirement period. Hitting clients with a big amount needed at the start of retirement just to fund the years leading up to age 70 might be the jolt needed to encourage clients to work a little longer. Or, for those with enough assets to ensure the bridge income, it can take some of the trepidation out of retiring and put them more at ease with their decision.