Why wait? 4 reasons why clients should file for Social Security early

September 12, 2023 6:36 PM

Social Security benefits are more generous for those who file later in life, but there are also benefits to filing early, experts say.

When it comes to filing for Social Security, there's an obvious reason to file as late as possible: The longer you wait, the bigger your monthly benefit will be.

But the decision is rarely that simple. In fact, financial advisors and other experts say there are numerous reasons why a retiree would be better off claiming on the younger side.

"Oh my, there are so many reasons to file early," said Howard Erman, founder of Erman Retirement Advisory — now owned by Edelman Financial Engines — in Seal Beach, California. "I will generally advise clients to take it early, whether they need the funds or not. The bigger award at later ages is a siren song."

Social Security is designed to make that siren song as tempting as possible. Full benefits are available to Americans who file at their full retirement age, which varies depending on what year they were born (for anyone born in 1960 or later, for example, the FRA is 67). And for those who wait even longer, delayed retirement credits add another 8% to the checks every year until age 70.

But few Americans take full advantage of these incentives. In 2021, according to the Congressional Research Service, only 18% of new Social Security beneficiaries were over 66 years old. And a recent study by Schroders, a British investment firm, found that only 10% of U.S. workers plan to wait until age 70.

"People's intention may be to wait, but they wind up taking it sooner," said Mary Johnson, a Social Security policy analyst at The Senior Citizens League. "What happens is life."

Why don't people wait longer? Some retirees need the money right away to cover expenses and emergencies. In other cases, claiming earlier actually makes more financial sense. So when advising clients on the Social Security question, here are four factors in the "file early" column for wealth managers to consider.

Taxes

Social Security isn't the only income a retiree might want to postpone. Withdrawing money early from certain retirement plans, for example, can trigger significant tax consequences. With both 401(k)s and traditional (not Roth) IRAs, if a participant disburses funds before they're 59½ years old, they face a tax penalty of 10% of their withdrawal. And at any age, whatever money they take out gets added to their taxable income.

One way to minimize all this: Collect Social Security first and your retirement savings later. For those years in between, your portfolio continues to grow and your taxes aren't soaring due to withdrawals.

Robin Hovis, a financial advisor at LPL Financial in Millersburg, Ohio, said this is how he advises many of his clients — although he always encourages them to wait until their full retirement age.

"You definitely are better off taking the Social Security at the FRA rather than waiting till age 70," Hovis said. "For, let's say, four years, from age 67 to 70, you have avoided paying taxes and being in a higher tax bracket."

Investing

Just because someone collects Social Security doesn't mean they have to spend it. If they're not relying on that money for necessities, they could invest it instead.

"If Social Security income is 100% discretionary for you …. then it can make sense to claim it early and fully invest that money," said Eric Amzalag, owner of Peak Financial Planning in Woodland Hills, California. "It is an assumption, but using average historic rates of return, claiming Social Security and investing it in an S&P 500 index fund would outperform the total distributions."

This approach is not guaranteed to succeed, but historical data supports it. For every year someone waits to file for Social Security after their full retirement age, the delayed retirement credit adds 8% per year to their checks. The S&P 500, meanwhile, has yielded an average annualized return of 10.15% since 1957. So in theory, the invested benefits would grow faster.

For clients who are relatively affluent, Hovis agreed with this approach.

"If they do a reasonably good job of investing, or if I do a prudent job of investing their money for them, I think they'll surpass the 8% automatic increase that they would have gotten by waiting," Hovis said. "As long as they do better than 8% a year on average, they win."

Health

Not every client, however, can afford not to spend their benefits. One reason for that is the high cost of healthcare for American seniors. The average 65-year-old will spend $157,500 on medical expenses over the course of their retirement, according to a study by Fidelity Investments.

"When you age, you are going to have to expect changes in your health," Johnson said. "There are going to be emergencies, and you may need the money."

Even apart from the costs of medicine and doctors' visits, deteriorating health can necessitate a myriad of other services, all of which cost money.

"It's not only your prescription drugs," Johnson said. "You may need more help with house cleaning or maintaining your property. You may need help with transportation because you can't drive. ... Those things gradually add up."

For a retiree grappling with all these new bills, Social Security can offer a lifeline — and it may be that they can't afford to wait.

Lifespan

The fourth factor to consider is simple: No one knows how long they're going to live. Theoretically, Social Security benefits are at their most generous when one files at age 70, but what good is that if the beneficiary dies in their 60s?

To illustrate this, Hovis told a story from his own family.

"My dad asked me when he turned 62 whether he should claim his Social Security at that time," Hovis said. "I advised him to wait until he reached 65, which was the FRA for everyone at that time."

His old man didn't take that advice. A few months later, Hovis' mother revealed he had started collecting Social Security at 62, drastically reducing his benefits. Sadly, he died of a heart attack just a few years later, at age 66. But in hindsight, Hovis is glad his father ignored his tip.

"If he had listened to me, he would have only drawn a benefit for about 12 to 15 months," Hovis said. "Even though his benefit was two-thirds of the full benefit, he drew it for over five years. He still got more money out of the system."

Stories like these are a reminder that even with the most meticulous financial planning, nothing in life is guaranteed. And for advisors like Hovis, it also underscores the importance of factoring a client's health history into their financial plans — including for Social Security.

"If a person has a history of heart disease in their family, or their uncles and grandparents and so forth don't live past age 70, then I think that becomes a factor in making the decision," Hovis said.

But there's also another lesson: If a client's health is likely to be much better at the beginning of their retirement, that may be the better time to make use of some extra income. Many advisors see this as a good reason to file for Social Security sooner rather than later.

"The non-financial and very important reason is to take the money at a time in life when you are best able to enjoy the extra funds," Erman said. "Travel, ease of stress, help for family are all reasons to have the money early."