Which Social Security Claiming Strategy Leads to More Portfolio Withdrawals?
By Zeke Anders on March 15, 2024
Claiming Social Security benefits is one of the most important decisions retirees will make. We have talked about Social Security before (here), but in this piece we will focus on the impact of Social Security on portfolio withdrawals. You can claim Social Security benefits as early as age 62 or as late as age 70. In many cases, people claim Social Security as soon as they retire. This may be because of the desire to replace their paycheck or hesitation to take withdrawals from the portfolio. Initially, claiming Social Security early will reduce withdrawals from the portfolio, but in this case study we’ll see that over the long-term claiming early may lead to higher cumulative withdrawals.
For this example, we’ll look at an individual with a portfolio of $2,000,000. Their Social Security benefit at age 62 is $30,864, at age 67 is $43,524, and $54,660 at age 70. These are the maximum benefits for a given person retiring this year at each age. They want to spend $110,000 per year, adjusted for inflation. This is roughly 4% of the starting balance plus the age 62 benefit amount. We assume inflation will be 2.5%, which is low for where we are today (as of March, 2024), but similar to historical inflation in the U.S. We’re looking at an individual because Social Security claiming strategies for a couple are much more complex. In practice, it often makes sense for one spouse to claim early and for one spouse to delay claiming, but that will depend on many factors. For the scenarios where the individual waits to claim Social Security, all their spending will come from the portfolio from age 62 until they claim their benefits.
The chart below shows the cumulative portfolio withdrawals over time for each strategy.
For Illustrative Purposes Only – Source: Author’s own calculations
You can see that around age 77 the lines converge, meaning that cumulative withdrawals from the portfolio are roughly even. Beyond that point, cumulative withdrawals are higher for the “claim at 62” strategy than claiming at age 67 or 70. The gap widens the longer the individual lives, since the higher social security payments continue for life. This only looks at side of the decision, however. There’s an opportunity cost to delaying, in that your investments are potentially growing in the early years, and claiming early allows you to keep more assets invested. So next, we’ll look at the portfolio balance over time for each strategy.
The three charts below show the year-end portfolio balance for each strategy at 6%, 7%, and 8% growth rates for the portfolio.
For Illustrative Purposes Only – Source: Author’s own calculations
For Illustrative Purposes Only – Source: Author’s own calculations
For Illustrative Purposes Only – Source: Author’s own calculations
You’ll notice that the growth rate shifts the breakeven point. At 6% growth the breakeven point is around age 84, at 7% growth breakeven is around age 86, and at 8% growth the breakeven point is around age 89. The higher the expected growth rate on your investments, the more it makes sense to claim social security early. That said, in all three cases the advantage of claiming early diminishes the longer you live, so if you expect to live a long time it might make more sense to delay claiming. None of us knows what investment returns will be in the future. As of March 4th, 2024, 3-month Treasury bills are yielding 5.38%, 10-year Treasury notes are yielding 4.23%, and 30-year Treasury bonds are yielding 4.36%. The rate of returns on U.S. equities since 1900 through 2022 was 9.5%[1]. Future returns may not resemble the past, but if you have a more conservative allocation or a more pessimistic view of markets you may prefer waiting to claim your benefits. That said, we know that markets are volatile and we can’t count on flat, steady growth in the portfolio.
We have talked before about sequence of returns risk (here and here) and how investment returns early in retirement have an outsized impact on retirement outcomes. It seems intuitive that claiming Social Security early would reduce sequence of returns risk since it reduces portfolio withdrawals early in retirement, but research from Dr. Wade Pfau and Steve Parrish of the American College for Financial Services found that waiting to claim social security generally had higher success rates and legacy values when market returns were poor or mediocre early in retirement returns (a summary of their research is here). Claiming Social Security benefits early performed the best when early market returns were above average, because more of the portfolio remained early on to catch the returns. The question, then, is would you rather have a larger legacy in the best-case scenario, when any strategy would perform relatively well, or potentially improve the outcome in sub-optimal scenarios?
Lastly, we have not modeled taxes in this case study, but it is worth noting that many states, including Alabama, do not tax Social Security benefits[2], and at the federal level benefits are at most 85% taxable. Distributions from a 401(k) or Traditional IRA, on the other hand, are 100% taxable as ordinary income. Waiting to claim Social Security benefits provides a bigger, tax-advantaged income stream, too. Withdrawals from a taxable account might only be taxed at capital gains rates and may benefit from tax-loss harvesting or return of basis, but eventually 401(k) and Traditional IRA owners will be required to take distributions each year[3] which may be taxed at a higher rate.
Claiming Social Security benefits is an important decision for retirees. It may seem like claiming Social Security early is the best way to limit portfolio withdrawals, but as we’ve shown that is not necessarily true over a long retirement. Additionally, claiming social security early may perform better when investment returns are good, but delaying benefits may be better if returns are not as good as expected. Delaying Social Security also tends to look better the longer you live, whereas claiming early looks better if you don’t live very long. We looked at a simple example of an individual, but the decision is more complicated for spouses, due to spousal and survivor benefits. Ultimately, there is a lot of uncertainty and there’s no “correct” answer, we just have to make a decision based on the strengths and risks of each strategy.
[1] Credit Suisse Investment Returns Yearbook 2023, page 14, accessed March 04, 2024
[2] https://www.nerdwallet.com/article/investing/social-security/which-states-tax-social-security-benefits
[3] https://twickenhamadvisors.com/blogs/unobstructed-thoughts/about-required-minimum-distributions
Zeke Anders – Planning Specialist | zanders@twickenhamadvisors.com
Disclaimer
Securities are offered through Hightower Securities, LLC member FINRA and SIPC. Hightower Advisors, LLC or any of its affiliates do not provide tax or legal advice. This material is not intended or written to provide and should not be relied upon or used as a substitute for tax or legal advice. Information contained herein does not consider an individual’s or entity’s specific circumstances or applicable governing law, which may vary from jurisdiction to jurisdiction and be subject to change. Clients are urged to consult their tax or legal advisor for related questions.
Hightower Advisors, LLC is an SEC registered investment adviser. Securities are offered through Hightower Securities, LLC member FINRA and SIPC. Hightower Advisors, LLC or any of its affiliates do not provide tax or legal advice. This material is not intended or written to provide and should not be relied upon or used as a substitute for tax or legal advice. Information contained herein does not consider an individual’s or entity’s specific circumstances or applicable governing law, which may vary from jurisdiction to jurisdiction and be subject to change. Clients are urged to consult their tax or legal advisor for related questions.
