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Financial Planning Retired Investor Social Security

Using Portfolio Returns to Determine When to Claim Social Security Benefits

Upon reaching full retirement age, a retiree can look back at the performance of their nest egg portfolio to determine whether to claim immediately or wait until credits for delayed claiming stop.

by Brian L. Betker | August 2019

This article uses figures current in 2019.

At what age should you claim Social Security benefits? For a new retiree, this question involves a trade-off that is easy to recognize but difficult to analyze. The annual Social Security benefit increases by up to 8% per year as the claiming age is delayed from age 62 to 70, which suggests waiting as long as possible to claim. But the retiree will have to spend down their nest egg portfolio while waiting to claim that higher benefit, which increases the risk that the nest egg will be depleted, and the retiree will have to live on only what is provided by Social Security.

In a pair of recently published papers (one of which was written with my colleague Mike Alderson), I analyzed this trade-off using Monte Carlo simulation. Since the future is inherently unknowable, the best we can do is to make probabilistic statements about what might occur. The goal of the simulation exercise is to answer the question: Given the size of my nest egg portfolio and my annual consumption expenditures, if I claim Social Security benefits at a certain age, what is the probability that my nest egg portfolio will be exhausted before I die? [Editor’s note: Monte Carlo simulation calculates outcomes by randomizing data over a large number of scenarios.]

For illustrative purposes, I considered a newly retired 62-year-old male (or married couple) with the goal of achieving constant real (inflation-adjusted) consumption over his (their) remaining life-span(s). The new retiree elects to claim Social Security benefits at either age 62 (the earliest possible age to claim), 66 (full retirement age for someone retiring in 2018) or 70 (the age at which credits for delayed claiming stop). The best age to choose is the one that minimizes the probability of running out of money during a retiree’s lifetime. Of course, nothing forces a retiree to claim only at one of these three ages. However, more than 75% of all persons filing for Social Security benefits in 2013 did in fact claim at one of these three ages, and over one-third of retirees claimed at age 62.

It should be clear that the 62-year-old retiree doesn’t need to make an irrevocable choice to claim immediately, at age 66 or at age 70. In fact, the retiree has a valuable option that they can use upon turning 66: They can look back at the performance of their nest egg portfolio over the prior four years, and then either claim immediately or wait four more years. If portfolio returns have been high over the prior four years, waiting till age 70 to claim the higher benefit may be optimal. But, if the nest egg has underperformed, it may not be able to withstand four more years of withdrawals while the retiree waits to claim at age 70. In this case, the retiree should claim at age 66 rather than wait. The best decision depends not only on the prior investment performance of the retirement assets, but on the size of the original nest egg portfolio as well.

I investigate the benefits of using this “look-back” option, relative to the “static” strategy of pre-committing to claiming Social Security at a fixed future age.

Social Security Benefits

The retirement benefit available from Social Security depends on both career earnings and the age at which benefits are claimed. The current full retirement age (for someone turning 62 in 2018) is 66 years and four months. Benefits may be claimed as early as age 62, however. Benefits are reduced if a retiree claims prior to age 66 and increased if claiming is deferred beyond age 66 up to age 70. Married individuals are eligible for up to the greater of half of the spouse’s benefit or the benefit attributable to their own career earnings. When a spouse dies, the surviving spouse can receive the entire benefit of the deceased spouse, if it is larger than their own.

Methodology and Assumptions

I briefly introduce the assumptions built into the simulation model here. More technically minded readers who want more details about the simulation model are encouraged to consult the two papers referenced at the end of this article.

The model assumes that a retiree is eligible for the maximum Social Security benefit at any claiming age and has accumulated savings in amounts ranging from $100,000 to $1 million, which includes most U.S. households ages 55–64 who have any retirement savings.

A retiree’s life was simulated 10,000 times in every scenario. In each “life,” a year of death was assigned based on the current life tables used by the Social Security Administration. These tables estimate median life expectancies of about 85 years for males and 88 years for females.

The retiree’s portfolio was assumed to be invested in a 60%/40% mix of large-capitalization U.S. stocks and long-term U.S. Treasury bonds. (This mix consistently resulted in lower failure probabilities than other potential asset allocations.) For each year in a simulated life, returns to stocks and bonds, as well as inflation, were chosen by randomly drawing a year from the period 1926 through 2017. An objection to these assumptions might be that future annual returns to stocks and bonds may be lower than their historical averages. Thus, I re-ran every simulation on the assumption that stock and bond returns were 3% lower compared to their historical numbers. While lower portfolio returns affected the probability of exhausting the nest egg, conclusions about the best age to claim Social Security were largely unaffected.

The retiree is assumed to have the goal of constant real (inflation-adjusted) consumption. Age 62 consumption is set equal to 4% of the nest egg plus the age 62 Social Security benefit, and this amount is increased by the inflation rate for each subsequent year. Thus, if the retiree does not claim until age 70, the nest egg portfolio must withstand extra drawdowns (beyond the inflation-adjusted 4% withdrawals) for eight years while waiting to claim.

The simulations thus consider a newly retired 62-year-old individual and examine four different strategies for claiming Social Security. In the first three, the retiree pre-commits to claiming benefits at either age 62, 66 or 70. The fourth strategy allows four years to elapse, at which point the (now 66-year-old) retiree can assess the performance of the nest egg over the prior four years and use this information to help decide whether to claim benefits at age 66 or wait four more years to claim at age 70. Of course, in this scenario the retiree needs a definition of what constitutes “poor performance” of the nest egg portfolio. Poor performance was defined simply as an average portfolio return over the prior four years that was lower than the historical average from 1926 through 2017 for the 60% stock/40% bond portfolio, which is a return of 9.59%. (Variations on this definition, including simulations that reduced the real returns on stocks and bonds, didn’t generate results that are meaningfully different from the ones presented here.)

Results

The simulations produced “failure probabilities” (the probability that the nest egg will be exhausted prior to death) for a 62-year-old retiree for each of four Social Security claiming strategies: claim at 62, pre-commit to claiming at 66 or 70 and the “look-back” strategy whereby the decision to claim at 66 is conditioned on the nest egg portfolio’s performance over the previous four years. Table 1 presents the results for single male retirees followed by the results for married couples in Table 2. (Results for single females do not meaningfully differ from those for single males.)

Single Retirees

First, consider the scenario in which a person retires at age 62, invests retirement savings in a 60/40 stock/bond portfolio and either pre-commits to claiming benefits at age 62, 66 or 70, or decides to utilize their look-back option upon turning 66. Table 1 contains the results of this exercise, using historical returns to simulate future returns. The table presents failure probabilities for the optimal strategy (i.e., the one with the lowest failure probability). Recall that the retiree wishes to maintain constant real consumption over his remaining life-span; the table provides the probability that they will fail to achieve this goal.

Table 1 indicates that a 62-year-old retiree with $150,000 or less in savings should claim Social Security immediately, as failure is a near certainty if claiming is delayed until 66 or 70. The nest egg is simply too small to support four or eight years of withdrawals while waiting to collect a higher benefit. For wealth levels between $150,000 and $400,000, claiming at age 66 is optimal.

For wealth levels above $450,000, the look-back option provides significant value for the single retiree. At these wealth levels, the failure probability for the look-back strategy is lower than that of the strategy of pre-committing to claim at 66 or 70. Essentially, the look-back strategy allows the retiree to reduce the chances of making one of two mistakes. First, if the portfolio has performed well over the past four years, it may be a mistake to claim at 66, since the portfolio can now withstand four more years of larger withdrawals. Second, if the portfolio has performed poorly over the past four years, waiting until age 70 to claim will put too great of a burden on the now-depleted nest egg. Conditioning the decision to claim on recent portfolio performance helps avoid these mistakes and maximizes the odds that the retiree will achieve their goal of constant real consumption over their remaining life-span.

Married Couples

Recall that the Social Security survivorship benefit awards the surviving spouse with the benefit of the deceased, if higher than their own. The simulation examined whether using the look-back option in conjunction with the couple’s claiming decision can reduce the probability of exhausting the nest egg portfolio.

To accommodate married couples, this set of simulations assumed that both spouses retired at 62 and the lower-earning spouse claimed Social Security immediately. The higher-earning spouse then had to decide when to claim: age 62, 66 or 70.

Table 2 reports the results using historical returns to simulate future returns. Here, the range of wealth levels where the look-back strategy was optimal was narrower, due to the value of the survivor benefit. The look-back option was most valuable at wealth levels where “claim at 66” tended to be the best strategy for a single person. Rather than automatically claiming at 66 (thereby locking in a lower survivor benefit), the couple benefits by looking back at past portfolio returns. In scenarios where portfolio returns between ages 62 and 66 were above average, the higher earner should delay claiming until age 70, thus locking in the maximum survivor benefit. The higher expected survivor benefit for the lower-earning spouse outweighs the negative effect of four more years of spending exclusively from the nest egg portfolio. The nest egg is better positioned to withstand the additional spending due to its above-average performance in the prior four years.

At wealth levels above $500,000, the strategy of pre-committing to claim at age 70 is optimal. This strategy pre-commits to locking in the maximum survivor benefit for the lower-earning spouse. It dominates the look-back strategy in these cases, because here it would be a mistake to claim at age 66 just because the portfolio underperformed in the prior four years. At these wealth levels, the portfolio is large enough to withstand this underperformance, and the paramount concern becomes ensuring the highest possible survivor benefit.

The simulations thus highlight the importance of looking back at recent investment performance before deciding whether to claim Social Security benefits. If the nest egg portfolio has performed well, a retiree can be more confident in the decision to delay claiming and earn the guaranteed 8% increase in benefits for waiting an additional year up to age 70, and, for married couples, locking in a higher expected survivor benefit.

Conclusion

Using past average returns for a 60%/40% stock/bond portfolio to simulate future returns for a person retiring at age 62, optimal Social Security claiming strategies can be projected. A single person with $150,000 or less in savings should claim Social Security immediately. For singles with portfolios between $150,000 and $400,000 claiming at age 66 is optimal. At wealth levels above $450,000, the single person should not pre-commit to claiming Social Security at a certain age, but rather at age 66 look back at their portfolio performance: If performance was poor over the prior four years, they should start taking benefits; if performance was good they should delay starting benefits until age 70. For married couples retiring at age 62, whether to use the look-back strategy to decide when to start benefits hinges on maximizing Social Security survivor benefits.

This article summarizes results contained in two recent publications. The interested reader is referred to these articles for more background and details about the mechanics of the simulation model. 

“Does the Benefit of Deferring Social Security Offset the Opportunity Cost to Do So?,” by Michael J. Alderson and Brian L. Betker; Journal of Financial Planning, September 2017.

“What Is the Value of a ‘Lookback’ Strategy for Claiming Social Security?,” by Brian L. Betker; Journal of Financial Planning, May 2019.

Discussion

TWheeler from Vermont posted over 7 years ago:

Mr. Betker's analysis is valuable and could be helpful as _a part of_ a retiree's consideration when making the decision of when to begin social security payments. I have not read the referenced articles, so perhaps he has included a more complete analysis there. I am single and have just turned 66. I recently retired, so have been considering this question. My decision was to wait until age 70. I ran several monte carlo analyses similar to what Mr. Betker puts forward in order to assure myself that based on the size of my nest egg, the probability of sustaining my standard of living is great enough to be comfortable with the added risks of delaying the onset of social security payments. My decision was determined by an analysis of the following factors: 1) Tax considerations, which Mr. Beker ignores, were the driving factor. Between 66 and 70, if I have no income, I will have an opportunity to convert traditional IRA accts to Roth IRA accts, pay a lower tax rate to do so, and leave me and my heirs in a better position. (I assumed that the chances of higher taxes in the future are greater than the chances of lower taxes in the future.) 2) I am blessed to be in good health. In my analysis, the breakeven (after which I will have received more money from delaying social security) is 82 years old. If I were in poor health, I should take social security benefits earlier. 3)As Mr. Betker alluded, by delaying the onset of social security payments, I can re-consider my options annually (or more!) in the interim. I am not locked in to waiting until age 70. In other words, delaying the start of social security payments now gives me more flexibility during the next four years. Thank you to Mr. Betker for his cogent and (for me) timely analysis. For many, the simpler answer (to take social security immediately) will be the best answer.


Ronald McNay from CA posted over 7 years ago:

I believe a good look at the work done by the Stanford Longevity Center on this very subject would be invaluable! Essentially, there are few situations where one should NOT wait....


Rick from VA posted over 7 years ago:

Re Table2 for portfolios over $500k. It does seem logical that as portfolio sizes increase probability of failure also increases. Is this caused by the assumption that everyone spends 4 % of their portfolio? I would assume if one spent the same amount regardless of portfolio size that there would be more incentive to wait until 70 to claim, all else being equal. Another way to think about this is to consider whether claiming earlier and investing the excess funds would beat the 8% risk free yield the government is offering. Overall, the most important factors are ones which are not definitive; when will my spouse and I die?


Joe from WA posted over 6 years ago:

I had uncovered this effect in my own projections recently, and wondered if there were any studies on it. I found situations where claiming at 62 would allow a higher withdrawal rate while still keeping my desired size of estate at end of life. It depended on investment return and tax rates. Thanks for a timely article, and thanks also to TWheeler for pointing out the additional benefit of a Roth conversion period, which also figures in my plans.


adam from MA posted over 6 years ago:

I am 64 yrs old and am considering when to begin Social security benefits very carefully. My thought, which I have not seen discussed elsewhere is that at least a component of the decision should be market level at the time of retirement. Specifically, if we had a concurrent 40-50% decline in the market, which historically has taken many years to recover, perhaps one should file for SS benfits ASAP, to preserve investment dollars that will recover, but only several years hence.


Carl from NY posted over 6 years ago:

Interesting exercise but real life is more complicated. For example, this does not take into account pensions and working part-time and quality of life. I probably made the wrong decision two years ago. I retired at 64, reduced to part-time work and took social security. Since my wife has a great pension we do not have to touch my accounts. Two years ago the value was $1.524M and is now $1.751M. Sure the accounts could have been more had I continued to work but this is more than we need. And, now my wife is going to start her social security and we are building a new bigger and upgraded house with her income. So I could have optimized income by working full-time until I was 70 but what would be the point? A key takeaway may be to invest early in life and the decisions later on won't be critical. I started when I was 10 years old and never had a high-paying job.


Bruce Bodner from Massachusetts posted over 6 years ago:

I wish you had presented more data. For example, you state that "a 62-year-old retiree with $150,000 or less in savings should claim Social Security immediately, as failure is a near certainty if claiming is delayed until 66 or 70. The nest egg is simply too small to support four or eight years of withdrawals while waiting to collect a higher benefit." but you don't present your results. You only present what you claim is the optimum strategy at each nest egg level. Questions remain. Just how much better is the look back strategy vs waiting until age 70 for a single male with $500,000 ? Your health obviously figures in, so a healthy person may use your analysis to tip the decision if your data is close between two options. But we dont have your results.


Scott Neal from KY posted over 6 years ago:

Much too over-simplified to be drawing conclusions like this. Should consider working longer, taxes, consumption patterns, etc. Strongly suggest anyone confronted with the claiming decision to consult the work of Laurence Kotlikoff at Boston University. maximizemysocialsecurity.com


Paul W from CA posted over 6 years ago:

I think your conclusion on Page 36 August 2019 is a complete contradiction to what you suggest on page 26 for a 66 yr old with a portfolio over $459,000 in regards to when they take Social Security


Dan M from OR posted over 6 years ago:

Regarding the note from Paul W, is the contradiction in the conclusion on page 36 a typo?


John Lambert from NJ posted over 6 years ago:

Interesting approach. But assuming one has plenty of savings, the problem is maximizing retirement resources by timing the claiming decision. The big unknown is your date of death. I would love to see an article looking at people's ability to estimate their death date accurately with or without the help of a Physician and genetic tests. The other question that seems to be rarely discussed is whether Social Security is actuarially neutral. (i.e. it doesn't matter to Social Security when people claim) It can't be neutral because the benefit reductions for early claiming and benefit enhancements for late claiming are the same for men and women. And we know for a fact that men and women have different life spans. What I have seen in the actuarial literature suggest that no single man should wait until 70 to claim social security. The last 8% increase from 69 to 70 is just not large enough to compensate for the shortened average life span. I am not an actuary but as life curves are not straight lines it makes sense to me that Social Securities 8% per year increase after Full Retirement Age is not neutral. I object to the mass medias characterization of the 8% increases as large in relation to safe bond returns. The 8% increase doesn't continue for a fixed time but until you die. To make the point; consider if Social Security gave an 8% benefit increase for each year of delay from full retirement age until 100. Would you wait to claim until 100? Your payment would be almost 13 times larger than at Full Retirement Age but your odds of actually receiving any payment would be close to zero. Not even remotely actuarially neutral. The benefit percentage increase needs to increase every year to be fair!


Jean from AAII posted over 6 years ago:

Paul W and Dan M, yes, the conclusion misstated the suggestion for singles with wealth above $450,000. The sentence should read "If performance was poor over the prior four years, they should start taking benefits; if performance was good they should delay starting benefits until age 70." It has been corrected here and in the attached PDF. Apologies for the error.


Robert Muksian from Rhode Island posted over 6 years ago:

Being the author of one of the papers cited by Professor Betker, I am taking the liberty of commenting on his paper. First, there is a misstatement in the sentence, "Married individuals are eligible for the greater of half of the spouse's benefit..." The sentence should read ...eligible for "UP TO" the greater of half of the spouses benefit... The recipient of the spouse's benefit must be his or her full retirement age to receive 50% of the primary benefit. Secondly, planning one's future based on life expectancy is essentially a 50% guarantee that one will run out of money prior to death. Using Life Tables of the US Health and Human Services published in November, 2018, both males and females have probabilities slightly greater than 50% of reaching life expectancy ages for ages 66 and 70. Since the date of death is the common unknown, I always refer to breakeven ages--the age when total revenues from Social Security are equal from either of two starting ages. As an example a person claiming benefits this year (2019) and having always earned maximum taxable FICA wages would have benefits of $2,209 if 62 and $3,247 if delayed to age 66 and $4,575 if delayed to age 70, based on the assumptions of 3% wage growth and 2% COLAs into the future. The respective breakeven ages are 75 years 5 months for delay to age 66 and 78 years, 6 months for delay to age 70. the probabilities of reaching these ages are in the high 70%s for male and female. If one dies prior to breakeven it will have been an economic mistake to delay benefits. If one survives beyond breakeven it will have been an economic mistake to take the benefit early. (Regardless of portfolio performance) After breakeven the monthly benefit spread for delay increases geometrically until death, whenever, that occurs. Until then, one must adjust variable expenses to not outlive funds. I do not question Professor Betker's Monte Carlo simulations, but in every case there is a probability of not outliving one's fund. What then?


Jean from AAII posted over 6 years ago:

Robert Muksian, We have made the correction to the text. Thanks for adding to the conversation.


Ed from NC posted over 6 years ago:

Thanks Jean, for posting the correction. I was scratching my head wondering why the "probability of failure" increases with higher retirement savings. I would think the risk would decline. I too have been thinking about when to start taking Social Security. My current thinking is that, if my portfolio earned less over "X" years than the approximate 8% that my Social Security benefit will grow annually by delaying Social Security past my full retirement age, then I would delay taking Social Security. I'd rather spend down the assets earning a lower return than lose the approximate 8% growth in my Social Security. The other, unappealing alternative, is to take on more risk in my portfolio in order to achieve an 8% annual return. Anyone reading this, please comment if you disagree. Thanks.


Jim from NJ posted over 6 years ago:

I think the general idea advanced by this article has merit, especially for those in good health who are trying to insure they will not run out of money before they die. Consuming savings to fund a delay in the receipt of Social Security benefits can make sense when stock market returns are good. Another approach would be to use current stock market valuations and the prospects for future invest returns in lieu of the past 4 years investment returns. In other words liquidate savings to fund a delay in Social Security benefits while stock markets are richly valued and the future investment returns are likely to be below historical averages. ----------------------- An excellent discussion I have read on retirement income planning is contained in Milevsky's "Pensionize Your Nest Egg", a book I recommend to anyone who wants to better understand the key retirement income planning risks and the trade offs between achieving a sustainable retirement income and leaving a financial legacy inheritance to heirs or charity. ------------- Milevsky writes that retirement income is sustainable when one's guaranteed income sources such as pensions social security, and annuities cover one's retirement living expenses. Retirement income becomes less sustainable and less guaranteed when savings must be used to cover living expenses. However, having enough savings that are likely to generate a sufficient level of sustainable withdrawals enables one to close any retirement income sustainability gap that may exist when guaranteed income sources do not fully cover living expenses. -------------- The sustainability of ones lifetime retirement income should be considered when making a social security claiming decision. Delaying Social Security improves the sustainability of lifetime retirement income for someone who does not have a high percentage of their retirement expenses covered by guaranteed income sources, especially when that person has insufficient savings. Those with limited savings may be better off depleting their savings in order to delay social security and improve the sustainability of their lifetime retirement income stream. -------------- Other factors come into play once retirement income is sustainable (i.e. having a combination of sufficient guaranteed income and savings). Example factors might include: Maximizing social security benefits based on the probability of receiving the benefits. My calculations using the life expectancy tables found in Milevsky's book indicate that a Male claiming at age 68 and a Female claiming at age 70 are likely to maximize Social Security benefits based on the probability of living to receive them. This does not factor in inflation risk which favors delaying benefits. Delaying social security benefits to enable Roth IRA conversions at a low / lower income tax rates may also make sense to someone who has saved too much in a Traditional IRA. -------------- Married couples should consider claiming strategies that maximize Social Security benefits while both spouses are alive. e.g. The lower earning spouse claims early while the higher earning spouse defers claiming as long a possible. In most cases, once one spouse dies, the surviving spouse only receives the benefits of the higher earning spouse. -------------- Social Security claiming decision rules are complex making online calculators and low cost automated claiming option services worthwhile. Check out: https://opensocialsecurity.com https://maximizemysocialsecurity.com https://www.socialsecuritysolutions.com https://socialsecurityadvisors.com ------------- Finally if you decide to claim social security benefits to be effective after your Full Retirement age, but before reaching age 70, then I recommend commencing benefits starting in January if you want to receive delayed retirement benefits for the year you first claim. Though a quirk in the social regulations, claiming benefits between February and December delays the application and commencement of delayed retirement credits until the following January. When you claim between Feb and Dec you permanently lose delayed retirement credits for the year in which you initially claim. Delayed Retirement credits are correctly applied the following January based on the actual month you claim. This issue is avoided if you claim on or before Full Retirement Age or upon reaching age 70. Good luck


Tom from OH posted over 6 years ago:

I am also confused as to why the "probability of failure" increases with increased assets for a married couple. I did not see any response to this from the authors. Please explain. Thank You.


Michael Lassi from Oregon posted over 6 years ago:

Why do people focus only on rate of return and ignore cash flow. I analyzed the amount of total cash I would have at break even in my portfolio if I started SSA at 62 versus delaying and replacing SSA with portfolio funds. Reducing my portfolio by $25,000 for four years and delaying SSA to 66, nets me less total cash at break even, I assumed 15 years, compared to delaying and taking the higher benefit. I assumed a $1,000,000 portfolio and a 5% annual return.


Robert B from USA posted over 1 year ago:

Does this consider that social security replaces a smaller percent of income for higher earners? The 4% rule on a $100,000 portfolio is $4,000/yr, which is unfeasible and well below the poverty line.


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