Which Should You Take First, Social Security Or Your 401(k)?

Originally posted at Dallas Morning News on May 2017.

Social Security provides an enormous return for those who are patient.

Consider its retirement benefits. You can take them as early as 62 or as late as 70. If you wait until 70, your retirement benefit will be 76 percent higher, after adjusting for inflation, than if you had started at 62.

Yes, you give up eight years of benefits by waiting. But receiving a 76 percent larger check for 30 years (if you live to 100) is a very big deal.

Why is the reward so large for waiting until 70?

Two reasons: First, since you don’t take your retirement benefit before full retirement age (now 66), it won’t be reduced for every month you take it early; second, waiting beyond retirement age provides a bonus called the Delayed Retirement Credit.

That’s the mechanical explanation. The deeper reason is that Social Security compensates us for waiting because, on average, we’ll collect for fewer years.

Actually, Social Security overcompensates us, since its early-benefit-reduction and Delayed Retirement Credit formulas use decades-old survival probabilities and credit us for forgone interest — interest we could have earned on benefits taken early — at a much higher rate than in today’s market.

In geek speak, Social Security’s overcompensation provides a better than actuarial increase in return for delaying benefits.

But even without that overcompensation, it would still be a good idea to wait until 70 to take benefits. Why? Because securing a permanently higher benefit insures us against dying later than expected.

Concerns about waiting

Imagine making it to 100. That 76 percent higher check would be your saving grace. Still, there are three concerns with waiting.

First, doing so may keep family members from collecting on your work record.

Second, Congress may cut Social Security benefits. The chairman of the House Ways and Means Subcommittee, Sam Johnson, already introduced legislation to gradually do just this.

The third and greatest concern is being able to afford the wait.

Frank, a 65-year-old single friend of mine, recently told me that he was retiring immediately and taking his retirement benefit at 66. When I said he should wait four years, he said he couldn’t afford to. I asked, “Why not use your IRA money first?” He said he doesn’t want to pay taxes on withdrawals. He asked if I thought that was a good idea. I replied: “No. Withdrawing early when your taxes are low and taking Social Security when your benefits are high seems the better move.”

I told him I wanted to run him through my company’s software (from which I derive no income). But Frank is concerned about privacy and didn’t want to divulge his finances. So I extrapolated some data that should be close to the mark, given what I know about Frank’s situation.

Calculating the difference

Here’s what I assumed: Frank’s Social Security retirement benefit, if he starts collecting at 66 (his full retirement age), is $24,000 a year. He also has $250,000 in IRAs plus $75,000 in a bank account. His $300,000 house is paid off and costs him $4,000 in property taxes, insurance and maintenance.

I used my company’s free calculator, esplanner.com/basic. Other financial planning tools or professionals may be able to make similar calculations.

Here’s what I found: If Frank takes Social Security at 66 and starts withdrawing from his IRA at 70, he’ll be able to spend $28,710 each year clear through age 100, his maximum age of life. That $28,710 is after covering housing costs, taxes and Medicare Part B premiums. The amount is in today’s dollars.

What if Frank waits until 70 to take both Social Security and initial retirement account withdrawals? Now he’s very short on cash. The most he can spend each year before 70 is $10,656. After 70, his spending jumps to $35,805. That’s 25 percent larger than $28,710, but spending so little for the next five years is impossible.

Here’s a better plan. If Frank bunches his retirement account withdrawals between age 65 and 75 and waits until 70 to take Social Security benefits, his cash flow problem goes away. Now he can spend $30,413 every year until he hits 100.

That’s a 6 percent higher living standard than the $28,710, for the rest of his life!

Posted with permission from Mr. Kotlikoff. 

John C. Goodman is President of the Goodman Institute and Senior Fellow at The Independent Institute. His books include the soon-to-be-published updated edition of Priceless: Curing the Healthcare Crisis, the widely acclaimed A Better Choice: Healthcare Solutions for America, and New Way to Care: Social Protections that Put Families First. The Wall Street Journal and National Journal, among other media, have called him the “Father of Health Savings Accounts.”