Should you collect Social Security early and invest your benefits?

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Boston University economist Larry Kotlikoff has spent every week, for over two years, answering questions about what is likely your largest financial asset — your Social Security benefits. His Social Security original 34 “secrets,” his additional secrets, his Social Security “mistakes” and his Social Security gotchas have prompted so many of you to write in that we feature “Ask Larry” every Monday. Find a complete list of his columns here. And keep sending us your Social Security questions.

Kotlikoff’s state-of-the-art retirement software is available here, for free, in its “basic” version. His new book, “Get What’s Yours — the Secrets to Maxing Out Your Social Security Benefits,” (co-authored with Paul Solman and Making Sen$e Medicare columnist Phil Moeller) was published in February by Simon & Schuster.

Watch Larry explain how Paul and his wife could collect an extra $50,000 in Social Security benefits:

Michael – Cambria, Calif.: I am 63 until October and a marginally self-employed artist. My wife is employed nearly full time with an employer matching 401 (K) and two small retirement checks from previous employment. Each of us have a traditional IRA. My wife is 61 until September. Our combined annual taxable income is around $40,000 to $50,000.

My benefit is $1,600 a month if taken now, $2,015 if taken at 66 and $2,600 if taken at 70. I estimate that it would take until about age 77 to break even if I wait to 66 to claim, or age 80 to break even by waiting until age 70 compared to claiming now. I would like to take the early option and put part of the money each month into a traditional or Roth IRA to help offset the long-term loss of early filing.

So in a nutshell, we want to start me on Social Security now, put $1,200 a month of my early benefit on a construction loan and mortgage and put the remaining $400 a month into a traditional IRA or Roth IRA.

Can you describe the pros and cons of this idea and how a traditional versus Roth IRA would work in our situation?

Larry Kotlikoff: This is a terrible idea. You can’t count on dying on time. You can’t count on any risky investment paying off.

Social Security rewards us for waiting to collect in two ways.  First, it rewards us for the risk of not collecting anything when we wait, because we may die before we collect, or we may die soon after we start our delayed collection. Second, it rewards us for investing with Social Security. That is, not taking the money now means leaving it with Social Security, and Social Security is nice enough to effectively pay us interest on it. Social Security pays us roughly 3 percent above inflation for leaving our money with them in addition to compensating us for the risk of not getting anything or much back because we die too young.  

That’s three times higher than the market yield on long-term inflation-indexed bonds. So even if you want to do a break-even analysis, waiting until 70 makes much more sense for anyone. But break-even analysis is completely the wrong thing to consider when it comes to Social Security, which is an insurance product, not an investment product. With an insurance product, you need to worry about getting maximum coverage for the catastrophe that will hit, which in this case is living to 100. So stop trying to beat the market, and keep working. You’ll want to get a full spousal benefit on one of your work records. I can’t say which one without more information on your wife’s primary insurance amount.

Anonymous- Jacksonville, Fla.: I am 59 in June this year, and my wife was 63 in February. She has fibromyalgia, and her family has had a history of dying early — most in their late 50s. I want her to quit and enjoy our nine grandchildren before her health deteriorates too much and she cannot. She has not worked at jobs where there was any retirement. I have an IRA around $400,000 and my 401(k) at about $150,000. I can collect on it at 59 1/2. We have a mortgage at $1,500 a month, a car payment at $400. I want to try and take just enough of my retirement and let her wait on at least 66 to claim hers. I have always earned more. How can I maximize our retirement?

Larry Kotlikoff: I’m very sorry to hear about your wife’s health condition. You may want to file for your retirement benefit early, when your wife reaches her full retirement age. This will allow her to take her full spousal benefit and wait until 70 to collect her own retirement benefit. But her maximum, not her expected age of death, is critical for deciding what to do. So is the relative size of your earnings histories.

Jim – Fla.: My wife turned 66 in February, and I just turned 66 in April. From “Get What’s Yours” it seems that I should file and suspend for my retirement benefit and then my wife should file for her spousal benefit until age 70. (My benefit at age 70 is around $3,424 a month; my wife’s benefit at age 70 is around $993 a month.) My current benefit would be about $2,594 a month so her spousal benefit would be about $1,297 a month. Does that sound like the correct strategy for us? I assume that she would take this until I turn 70 then file for her retirement benefit. I also assume that once I take my retirement benefit, she can no longer take the spousal benefit and must take her retirement benefit. Correct?

By the way, loved the book!

Larry Kotlikoff: Glad you liked the book. Yes, your strategy is correct. Your wife will collect the larger of the two benefits — her spousal benefit and her retirement benefit — at age 70. So, in your case, she will just continue to collect her full spousal benefit.

K.M. – Woodinville, Wash.: I am 63, and my husband is 65. At this point we are not sure when he will begin taking his Social Security benefits, but definitely not before age 66. Can I begin my own benefits at age 64 and then switch to spousal benefits at age 66? (If I am assuming correctly, it would be 50 percent of his full retirement age benefit. This would be more than my full retirement benefit at age 66.)

Larry Kotlikoff: You can take your retirement benefit early, but the minute that you or anyone else files for a retirement benefit (even if they immediately suspend its collection), that person gets transported to excess benefit hell, where they can no longer get a full spousal benefit, full divorcee spousal benefit, full widow(er)’s benefit, full divorcee widow(er)’s benefit, full child-in-care spousal benefit or full mother (or father) benefit. So when you reach 66, you can either suspend your own retirement benefit and take your excess spousal benefit or you cannot suspend your retirement benefit and take your excess spousal benefit. Doing so will require your husband to file for his retirement benefit (and, if he wants to collect starting at 70, to suspend it upon filing). Either way, you will get your excess — not your full spousal benefit — which may well be zero. If your husband filed now, the story would be even worse. You’d be deemed to be filing for your excess spousal benefit at the same time as you file for your retirement benefit, and then it too would be reduced. In short, your plan is suboptimal. You should probably wait until 66 — full retirement age — and collect a full spousal benefit and then take your own retirement benefit at 70. Your husband should file and suspend when you hit 66 and then take his retirement benefit at 70. This assumes he’s the higher earner. If not, you might want to file for your retirement benefit when he reaches full retirement age so he can file for a full spousal benefit. At 70, he’d file for his retirement benefit. You would then suspend your retirement benefit at 66 and restart it at 70.

Iannette – Apple Valley, Calif.: I was wondering if I can apply for survivor’s benefits now? I will be 60 years old in November. My husband died in 2011. So can I apply now, or do I have to wait until I am 60 to do it?

Larry Kotlikoff: You can file now as in doing the paper work, but if you take your survivor benefit now it will be permanently reduced. That may be the best thing to do — take that benefit now and wait till 70 to collect your own retirement benefit. Or it might be better to take your own retirement benefit at 62 and take your widow’s benefit either at full retirement age or sometime earlier than that depending on whether or not your husband took his own retirement benefit early. Just be sure you are maximizing your lifetime benefits.

Janet – Normal, Ill.: My husband has been on Disability since 2006. He will be 59 in May 2015. I plan on retiring in June 2016 at the age of 61, taking half of his Social Security when I turn 62 a few months later and letting my benefits increase. (One half of my husband’s benefits is only $300 less than my benefit at 62.) Then at age 66, I’d flip over to my benefits. Is there a penalty if I do this?

Larry Kotlikoff: You can’t do this. You will be subject to deeming and forced to take your retirement benefit early. You’ll collect a reduced retirement benefit plus your excess spousal benefit, which sounds like it will be zero from what you wrote. In short, your plan is the worst possible option. The best thing to do is wait until full retirement, take just your spousal benefit and then at 70 take your retirement benefit. When your husband hits full retirement age, he can suspend his retirement benefit (his disability benefit turns into his retirement benefit at that point) and then he can restart his retirement benefit at 70. This assumes you both can live a very long time.

Bethanne: Between 2008 and 2009 my husband and I lost our retirement and life savings in the economic meltdown. We owned a construction business for 25 years and had to close it, because no one was building. We were each 56 at that time. No one was hiring either as businesses were closing at a record pace, so we had to use our savings to survive for four years.

My husband began taking his Social Security last year at age 62. He is suffering from arthritis and joint issues, and he didn’t feel he could continue to work, let alone the fact that no one would hire him at his age. We weren’t sure if he could apply for disability or not, so we opted to take early Social Security. I am eligible for early Social Security in January, and we’re not sure what our options are at this point. We feel strapped since we lost our retirement ($500,000) and have had a hard time starting over at our ages. We feel we planned, but the economy tanked and then it was gone. What could you suggest to maximize our options?

Larry Kotlikoff: I’m so sorry to hear this. The recession of 2008 was just terrible and didn’t have to take place. I suggest you both try to find some less physically demanding jobs and that you wait, if at all possible, until full retirement age to take your spousal benefit and take your own retirement benefit at 70. You husband should suspend his retirement benefit at full retirement age and restart it at 70. This assumes you both live long lives.