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Determining Break Even on Social Security Income

Determining Break Even on Social Security Income
Kevin Wenke

Kevin Wenke

CFP | CLU | Investing | Insurance | Taxes

The factors you should be looking at when considering how long it will take you to break-even when you wait to take Social Security retirement are more involved than you may think.

First of all, the decision of whether or not to take social security benefits as early as possible, the month you turn 62, at a reduced rate or wait until later to increase your payout is many times determined by when you will “break even.”

The break-even point is when that additional income you receive from waiting matches the income you would have received if you took benefits early.

Taking money now guarantees you receive some benefits but waiting until age 70 can almost double your monthly benefit in the future. 

Another way of saying this is that the additional income could help to create a hedge from outliving your money but there is the risk of passing away before collecting benefits that you are entitled to from years of contributions to the system.

There a number of factors that need to be considered when determining your break-even age as they play into your retirement decisions.

Determining social security income fig-1

First of all, you obviously need to consider your life expectancy.  Generally, if you are healthy it may benefit you to wait, but if you know you are not well and don’t have longevity in your family it may benefit you to take benefits as soon as possible.

Looking at this example, assuming this person is could either take their benefits now at full retirement age OR wait one year, not receive the $1000 per month but then when they do start benefits a year older receive an 8% increase (or an extra $80 per month of income for the rest of their life).

Determining social security income fig-2

When you look at just this factor alone, it looks like the person would need to live for 12 and a half years to break even. (Figure 2)

But that isn’t the only consideration.  If you want to do this analysis correctly, you should also consider what your money will do when it remains invested.

For example, if you take social Security early, that would mean you would NOT need to take the $1,000 out of your retirement accounts which allows those funds to continue to grow.

Social security investment returns

Analyzing anticipated, best guesses for how your investment can perform, (Figure 3) you can see that the break-even line changes based on anticipated returns.

Most investment advisors will assume an 8% return and as you can see in Figure 3 , if you were to earn an 8% return on your investments you won’t break even if you wait to take Social Security. 

CAUTION! This assumption is dangerous to your retirement! 

I discuss this common assumption in my book “Why the Stock Market” and my video on how Social Security is a great hedge to an investment portfolio-based retirement

In that video I discuss another consideration when it comes to break-even analysis for Social Security and that is consideration is inflation.

Since 1975, Social Security has had a built in Cost of living adjustment given to recipients (Chart 1.). This COLA, as it is also referred to, increases the entire benefit a recipient receives – including the additional credits for waiting.

Determining social security income fig-3

You can see that in times when inflation was high, like it was in 1980 and 1981, recipients received a 14.3% and 11.2% increase.

Simply put, 14% of $1,000 (the income if taken early) is less than 14% of $1,080 (income if delayed a year).  Over time these increases can really add up!

Looking at a graph in Figure 4, you can see the break even for both men and women with women break-even point pushed out further.

Notice in this graph, that it takes a long time to go from year one here to year 17, year 18, and year 19.  Further notice how the slope of the line accelerates from there.

This is the effect of the inflation rider adding more and more income to the recipients monthly check.  It is very hard, no impossible, to find any financial product that can perform like Social Security can perform when maximized.

There is one other factor to consider when looking at Social Security Break Even – Taxes

Determining social security income fig-4

Most people have their investments in retirement plans like IRAs and 401(k)s.  Money in traditional accounts like these has never been taxed.

This means keeping the money in those accounts is growing money for the tax man and just delaying the inevitable.  In addition, the distributions from these accounts increase what is known as you Adjusted Gross Income (AGI) which can influence the tax on your social security income.

The lower the AGI, the lower the taxes are on your social security and the more of it goes in your pocket and not to Uncle Sam’s.

Still, even the highest earners receive 15% of their social security income tax free making $1 from Social Security worth more than a dollar fully taxed from your retirement accounts.

Determining social security income fig-5

Generally speaking, an individual who doesn’t expect to live long and/or expects a great investment return and/or low inflation would lean toward taking benefits early.

On the other hand, an individual who expects to live a long life and/or have poor investment returns and/or high inflation would lean towards taking it later.

Determining social security income fig-5

This thought process is JUST a single individual though.  If you have a spouse, or even an ex-spouse, dependents or other financial goals they too can significantly influence your break-even point and decision regarding when to take benefits.

Other people can be eligible for both living and survivor benefit based on your work record and when you decide to take it can influence when and how much they can get.

Determining social security income fig-6

So as you can see, determining your break-even point when you wait requires you to consider a number of factors and make a few assumptions.

Therefore, the best way to make your decision on when to take Social Security retirement may not be to look at what point you will break-even but instead look to see how your decision affects the rest of your financial goals.

This is what Decision Tree Financial helps you determine with our Wealth Performance and Protection System.

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[…] you are considering taking early benefits you may also want to read determining break-even on social security income as well as how social security: the perfect investment […]

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