Understanding Social Security For Investors
Summary
- Social Security is a government program designed to provide a guaranteed income to retirees. It's vital for investors to understand how the program works and how benefits are calculated in order to understand Social Security's place within a broader investment portfolio and retirement budget.
insta_photos/iStock via Getty Images
What Is Social Security?
The Social Security Administration (SSA) is a U.S. government agency which administers Social Security and various other government benefits programs.
Its namesake program is old-age, survivors, and disability insurance (OASDI), which is more commonly known as Social Security. This provides qualified benefits to retirees and other eligible people. Funds for this are obtained primarily from a payroll tax on employees' wages.
SSA Benefits & Services
The Social Security Administration (SSA) is widely-known for its standard retirement pension program. However, the SSA is also involved in a variety of other benefits and services for Americans including:
- Disability: The Social Security Disability Insurance (SSDI) program pays benefits to eligible workers who become disabled prior to reaching retirement age.
- Medicare: The SSA is involved in administering some parts of the Medicare program in conjunction with the Centers for Medicare and Medicaid Services.
- Survivors: Social Security pays benefits to widows, widowers and dependents of eligible workers.
- Supplemental Security Income: This program pays benefits to adults and dependents who have disabilities or blindness and whose income falls below a certain threshold.
How Does Social Security Work?
Social Security is designed to replace a portion of a person's pre-retirement income. People pay into the system through a payroll tax. The SSA keeps track of a participant's earnings and then calculates benefits based on the highest 35 years of their income during their working life. The benefit earned is also adjusted by when a person starts to collect benefits.
Social Security is primarily funded by the payroll tax on current workers. Contrary to some public perceptions, money paid into social security isn't held in personal accounts for each future retiree. Rather, funds that go in today pay current retirees or are placed in a trust fund which is available to meet the SSA's future obligations.
Who Collects Social Security?
American citizens and lawfully present residents are eligible for Social Security. To receive payments, an eligible person must earn enough work credits to quality.
The SSA measures people's contributions to the program through work credits. A person can quality for up to four work credits per year depending on the amount of payroll tax contributed into the system. The threshold is generally quite low; in 2022, a person earns one Social Security credit for every $1,510 in covered earnings each year up to the maximum of four credits per year.
Meanwhile, to receive eligibility, a person must accumulate at least 40 work credits before retirement. This can generally be accomplished by working full-time for 10 years, as each year of full-time employment will generate enough wages to earn the maximum four work credits annually.
When To Start Taking Social Security
The Social Security Administration gives retirees flexibility in terms of when they wish to start receiving benefits. People can begin to receive their benefits from the program as early as age 62 but this comes with a serious penalty to the overall size of their benefit.
Meanwhile, if people wait until the full retirement age, which is age 67 for those born in the year 1960 or after, they receive their full benefit. And for retirees that hold off beyond 67, they earn additional credits and become eligible for a larger payment. These delayed retirement benefits can continue to accrue until age 70.
For investors, it's important to think through the ramifications of this decision. The choice of when to draw Social Security can affect a person's payments by hundreds of dollars per month. That really adds up. It also impacts other investing decisions, such as what allocations of a portfolio to put into equities versus fixed income or between dividend stocks and growth stocks.
Social Security Retirement Age Chart
Those eligible can begin to collect retirement benefits as soon as age 62. But they take a significant hit in terms of the amount of benefit received compared to if they wait until the full retirement age.
The following table shows the benefits for a person who was born in 1960 and could begin to draw early retirement benefits in 2022.
Year To Collect Benefits | Reduced Retirement Benefits Received | Reduced Retirement Benefits Received by Spouse |
62 | 70% | 32.5% |
62 & 6 months | 72.5% | 33.8% |
63 | 75% | 35% |
63 & 6 months | 77.5% | 36.3% |
64 | 80% | 37.5% |
64 & 6 months | 83.3% | 39.6% |
65 | 86.7% | 41.7% |
65 & 6 months | 90% | 43.8% |
66 | 93.3% | 45.8% |
66 & 6 months | 96.7% | 47.9% |
67 | 100% | 50% |
Important: This table is not all-encompassing, as the full retirement age has been gradually raised over time. A person born between 1943 and 1954, for example, would have had a full retirement age of 66 instead of 67. However, 67 is the full retirement age for people currently at the threshold of starting to draw Social Security benefits today.
Applying For Social Security at 62 vs. 67 vs. 70
According to the Social Security Administration, the average benefits check going out as of March 2022 is now $1,537. For a hypothetical example, let's say a new retiree born in 1960 is eligible for a monthly benefit of $1,500 per month. The below sections will show how this retiree's income changes depending on the date they elect to start receiving social security benefits.
How Much Social Security One Will Get at 62
If they elect to start drawing benefits at age 62, as per the above chart, they will receive 70% of their stated benefit, or $1,050 per month.
Between ages 62 and 67, this person would collect $63,000 in benefits. However, it's at the expense of $450/month for the rest of their life when they would have started collecting $1,500/month instead of the reduced rate.
Starting Social Security at 67
Meanwhile, by waiting to age 67, the person would be entitled to $1,500 per month instead of the $1,050 they'd get if they start taking benefits at age 62. By giving up the $63,000 of upfront benefits between age 62 and 67, in effect, they'd then keep the extra $450/month, which works out to $5,400 per year.
The breakeven point would come after 11 years and 8 months, where the person who waited to age 67 catches up to the total cumulative benefits received by someone who took benefits at age 62.
Note: A person who expects to live to age 79 or beyond would be projected to earn more total cumulative dollars from Social Security by waiting until age 67 to start claiming benefits.
Filing to Collect at 70
A person who waits until age 70 to start collecting Social Security would be entitled to the maximum 24% delayed retirement credits, meaning that they'd get 124% of their original $1,500 per month, or $1,860. However, to receive that extra $360 per month of additional benefits, they would have to give up $45,000 of cumulative benefits between age 67 and 70 to earn the added payments for taking late Social Security.
Retirement Planning & Social Security for Investors
Social Security, in effect, serves as a fixed income for individuals as they enter their retirement years. By having a set amount of dollars coming in from Social Security, it reduces the amount of money a retiree needs to distribute from other sources. This can extend the duration of one's private retirement assets by allowing a lower portfolio withdrawal rate.
Social Security also serves as a sort of unique asset within a retirement portfolio since it is adjusted for inflation automatically. This can provide a steady income stream within a broader portfolio allowing for an investor to hold onto other assets with less certain cash flow characteristics, such as growth equities.
Most people probably shouldn't make Social Security the cornerstone of their retirement plan. The benefits don't tend to be large enough to support the sort of lifestyle people maintained during their working years. But the payments are certainly enough to make an impact within the context of a broader retirement portfolio. As such, it makes sense to include Social Security when planning one's full financial picture.
Some younger investors hesitate to include Social Security in their retirement planning due to concerns about it being adequately funded. However, the odds of Social Security going away anytime soon are low. Rather, younger investors might consider planning on having the retirement age be increased, or have payments trimmed slightly as Congress may tinker with the system to keep it adequately funded. A conservative way to think about this might be to include, say, 80% of one's expected payments in retirement plans in case anticipated benefits are slightly reduced.
Taking Social Security Early vs. Distributing Money From Investment Accounts
There are a variety of factors which can impact whether it is more advantageous to start withdrawing funds from retirement accounts at age 62 or take Social Security benefits early.
- Present Cash Flow: If a person wants to retire but needs additional immediate income to make that feasible at age 62, early retirement might be a good choice as long as their overall investment portfolio is large enough to meet their longer-term needs. However, if a person is happily employed, there may be much less reason to start drawing early benefits, as the reward is quite generous for waiting until the full retirement age or later to start claiming Social Security.
- Taxes: Depending on where a person's retirement funds are primarily located (i.e. tax-sheltered accounts or not) makes a big difference in terms of how taxation will affect this choice.
- Inflation: Don't overlook the fact that Social Security income is indexed to increase with inflation. Right now, as inflation is surging, this makes it more attractive to try to maximize one's Social Security benefits if and when possible. That said, investors that have a significant portion of their capital in annuities or other private investment products with inflation protection might place less value on this Social Security feature.
Bottom Line
Social Security can be a key component of a person's retirement planning and budget. Understanding how Social Security benefits change depending on the age of claiming them can be integral in designing the right allocations for the rest of a portfolio and managing resulting decisions around withdrawal rates and tax planning.
This article was written by
Ian Bezek is a former hedge fund analyst at Kerrisdale Capital. He has spent the decade living in Latin America, doing the boots-on-the ground research for investors interested in markets such as Mexico, Colombia, and Chile. He also specializes in high-quality compounders and growth stocks at reasonable prices in the US and other developed markets.
Ian leads the investing group Learn more .Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
Recommended For You
Comments (11)
John.
As for whether to take SS at 62 or 67 or 70 I would say that it really depends on your family's history and how long family members live for. I've seen many friends die before they even collected a penny. I did do a little research and found that if you retired at 62 rather than retiring at 70 that even though you got far more money at 70 that it would take the person that retired at 70 till they were over 80 before they equaled out to the person who retired at 62 in amount of money received. Which gives some food for thought. I can also see how all of this has to enter your investment thesis for the future.
As for the current benefits continuing, I think they will, but I would not surprised to see indirect cuts through reduced cost of living, or computation of benefits.
Since almost everyone is required by law to participate in Social Security, one can also develop the argument that its untended consequence is to transfer wealth from male American Indians, male Alaskan Natives and Black males to Asian females, Hispanic females and Asian males....
See figure 4 in link below;
www.cdc.gov/...
