Various investment articles and advisers routinely advocate that retirees delay when they will start taking Social Security without any explanation of how they come to this conclusion. This means a retiree would need to draw more from his or her investments until he/she starts taking Social Security, decreasing income from investments to cover his expenses in those years. If Social Security pays more in subsequent years, would the upfront risk yield a reasonable investment? And since Congress has been known to change the law from time to time five years is a long time to assume that the payoff would remain wonderful over that period.
Not willing to blindly follow generic advice I took a detailed look at the numbers. This yielded an interesting and potentially useful set of curves.
My hypothetical retiree, John Doe, has reached 65 years of age with $500,000 of investments to use during retirement in tax favored accounts so that Income Taxes is not a factor. These investments yield in an average year 4% more than inflation. If he were to begin taking his Social Security benefit at age 65 he would get $24,000 from the Social Security Administration. But every year that he delays taking Social Security his benefit would grow by 8% more than inflation. His expenses exactly equal his first year Social Security benefit plus 4% of his investments or $44,000. On average, his expenses increase only due to inflation over his retirement.
Thus if this retiree starts taking Social Security on the month he becomes eligible his income ($500,000 x 4% = $20,000 plus $24,000 from Social Security) would match his expenses ($44,000). Since my hypothetical retiree is not affected by inflation his investment would never fall below, nor rise above $500,000.
But if he waits to start Social Security, in the first year his expenses would exceed his income thus he would have to draw more than 4% from his investments each year until he starts taking Social Security. Essentially he is taking an interest free loan from his investments with the hopes that by delaying Social Security his income would be much higher. In the first year he would need to draw an extra $24,000, decreasing his investments to $476,000. Because his investments decreased he would have less income in the second year from investments ($476,000 x 4% = $19,040) and thus need to draw even more from his investments in each subsequent year that he delays starting Social Security.
Fortunately each year Mr. Doe delays Social Security, his benefit would rise by 8% each year. So if he were to start taking Social Security when he turned 66 his benefit would be $25,920, an extra $1,920! Thus his total income that year would be $44,960, $960 more than if he had taken Social Security in the first year. If he waits even longer his total income would rise each year until he reached 70 years old.
But how old would this retiree be when this extra income covered the extra withdrawal he needed to make in his first year? About 84 to 86 years old. Approximately 6 to 8 years longer than the average life expectancy of a US citizen at 65 years old. Thus our hypothetical retiree is not likely to see the benefit of waiting to start taking Social Security.
On the other hand, since Mr Doe has investments beyond his immediate needs, he might set aside $100,000 for a more aggressive style starting when he is 65 until he is about 85 years of age, should he live that long.