What Happens if You Invest Your Social Security Income?

Someone recently asked me whether they ought to take Social Security early and invest it rather than wait to claim it until full retirement age or later. While I usually tend to recommend an "if in doubt, wait" approach, when I ran the numbers I was surprised. It isn't quite so black or white as I had thought, and the data actually suggest that you can tailor the Social Security decision depending on which risks you want to hedge.

If you are concerned about dying early, you should almost certainly take Social Security sooner than later. This is true as long as you don't have wages that would reduce your monthly benefits.

On the other hand, someone who is more concerned about market volatility or the risk of a "lost decade" for equities, might be more comfortable waiting to take Social Security. By maximizing their benefits they increase the amount of their monthly cash flow which is not dependent on investment performance.

Then again, an increasing number of retirees are concerned about the Social Security program itself. It is essentially insolvent as-is, with "a day of reckoning" looming somewhere in 2032, in which retirees will see a 25% cut to their benefits unless Congress reforms the program between then and now. Reforms might include slight reductions in benefits, such as shrinking the amount of the annual adjustment for inflation. We'll see.

But of course, the best decision depends on what you expect for your own particular situation, as well as inflation and investment returns. Let's run some hypotheticals to give you a feel for the breakeven.

If you expect a 10% annual growth rate on your money, and a 3% inflation rate, you're better off taking Social Security sooner than later. You only become "money ahead" at age 97 by waiting. Few people live this long. So if you think a 10% return is attainable, and that Social Security's annual inflation adjustments will not exceed 3%, I say take the money and run.

Some might ask whether a 10% expected return is realistic for a retiree. And I would say it depends. On their entire portfolio? Probably not, at least not unless they have a crazy high risk tolerance and minimal need to draw from those savings. But how about the portion that would have been in bonds if they had been waiting to take Social Security? Social Security reduces the need for portfolio security, so it's entirely plausible to me that someone could invest more aggressively after starting their benefits. Stocks have averaged about 10% a year historically.

This approach (take Social Security and invest the difference) hedges early mortality nicely. For instance, suppose that your full retirement age benefit at 67 were $3072. If you passed away at 74, but started Social Security at age 64 you'd have $618,693 from your invested benefits, vs $338,834 if you had waited until age 70 to take Social Security. That's a big difference.

This strategy could potentially be a smart choice for couples. After all, when one spouse dies, you lose the lower of your two monthly paychecks. That would be especially devastating for households where both partners had similar income throughout their careers, as it would lead to a 50% reduction in Social Security income. Best case scenario, where one partner was the primary earner, the cut would be about 33%, which is still quite large. However, if a couple takes Social Security sooner, it reduces their need for portfolio distributions and lets their retirement assets grow faster over time. Thus the surviving spouse has more financial cushion after their partner's passing.

But on the other hand, if you expect poor returns on your investments, waiting for Social Security becomes a better deal. If your investments were to grow at 4% annually instead of 10%, and inflation averaged 4% a year, Social Security becomes a good deal for you if you live beyond age 80. Statistically, this includes is quite a few retirees.

Ultimately it depends on which risks you're willing to live with. If you think you'll live a long time, get the full amount of Social Security promised on your benefit statement, as well as the associated inflation adjustments, it might make sense to wait and maximize your benefits. Particularly if you think inflation will be a little on the high side, while investment performance struggles. But if you think you or your partner might die a little on the younger side, or if you foresee significant cuts to the Social Security program, I think it probably works just fine to start taking benefits sooner than later. This would give you a little more cushion against future reductions in income.