“I questioned you, everyone I talked to questioned you, but you were right.”
Those are the words of a client with whom I met just the other day. He was referring to advice that I gave him when he retired to delay the election of his Social Security retirement benefits. The “everyone” in his statement was a reference to co-workers of his who retired about the same time he did.
Apparently, a lot of his co-workers, or at least the ones with whom he spoke, thought that delaying benefits was a bad idea. In fact, some of those folks apparently elected to receive their Social Security benefits immediately upon retiring. My client shared with me that some have also been prematurely depleting their investments and at a fairly brisk clip. He attributed their predicament and the fact that he has not suffered the same fate, directly to the timing of Social Security benefits.
One of the things that the exchange with my client highlights is a problem that experience has taught me is fairly universal. The problem, as I would define it, is understanding that the best financial decisions will not only appear to be the best in current circumstances, but future circumstances, and those found across as many contingency scenarios as possible. Specific to Social Security, we are talking about the best decision between making an early, or immediate, election (present) to receive benefits or to defer that decision (future).
Analyzing Social Security Benefits to Find the Best Strategy
When I analyze Social Security strategies for a client, my goal is to determine what the best strategy is for that individual. Absent other considerations, what I am looking for, specifically, is the strategy that gives a client’s plan the most flexibility. In other words, I’m looking for the strategy that does the best job of preserving, and maybe even growing, a client’s assets over the course of their plan.
The reason why the strategy that is designed to preserve and/or grow invested assets the best is also the one that affords the most flexibility is because only through maximizing the preservation and/or growth of investment assets do we achieve the greatest flexibility possible. To explore this a bit, consider the simple fact that fixed income sources, like Social Security, offer no flexibility whatsoever. Once you elect to receive benefits, you get what you get, and that’s it. Sure, you might receive the occasional cost-of-living adjustments, but it’s not like you can go back to the Social Security Administration and request an additional check.
As long as there is money in an investment account, though, you can always request another check, and obviously, the greater the value of our investments, the more we can rely upon them. Building a plan that makes investment resiliency a core aim is another way of understanding what it means to maximize the flexibility of a financial plan. Aiming for the greatest resilience and flexibility is the essence of what it means to pursue the decisions we make will look the best in the present, the future, and across as many contingency scenarios as possible.
Withdrawal Strain: What is Sustainable and What is Not
Essentially, evaluating Social Security strategies is a bit of a misnomer, though, because if we’re focused on the resiliency of investments as our tell for the best Social Security strategy, then what we’re really evaluating is a concept that I call withdrawal strain. Simply put, this is the extent to which we rely upon withdrawals from investments to support our lifestyle.
The rate at which we withdraw funds, or the withdrawal strain, can be understood to come in two forms: sustainable and unsustainable. A simple way to understand the difference between the two is that an unsustainable withdrawal strain will prematurely exhaust invested assets and a sustainable strain won’t. It shouldn’t be a surprise, but the most sustainable withdrawal strain also affords the greatest resiliency and flexibility.
It is often the case that withdrawal strain will vary over the course of someone’s plan, and maybe even considerably so. One factor that has a direct role in determining withdrawal strain, and the degree to which it varies, is the timing of receiving Social Security benefits. What this means is that, if we aren’t paying attention, or do not account for this at all, we risk electing a suboptimal Social Security strategy.
Absent other considerations, a suboptimal Social Security strategy is simply one that results in an unsustainable withdrawal strain. It is not necessarily the case that an early, or immediate, election of benefits, or a deferred election, will automatically result in unsustainable withdrawals. It is also not necessarily the case that any strategy automatically prevents such a thing. An individual’s circumstances ultimately govern whether an early or deferred election of benefits poses a sustainability risk. While both can certainly result in such risk, the way in which it manifests itself differs a bit between the two.
The depletion of investments that could result from receiving benefits too late is basically an accelerated depletion. This comes from relying upon investments too heavily until, and through, Social Security benefits being elected. What basically happens in this scenario is that, prior to receiving Social Security benefits, assets are depleted to the point that additional, necessary withdrawals cannot be sustained, even upon Social Security being elected. The reason for this is simply that withdrawals have been too substantial prior to the commencement of benefits.
What is the Best Strategy?
An election of benefits that is too early results in an unsustainable withdrawal strain when benefits don’t cover enough of our expenses from the very start. For the uninitiated, there is a penalty that is applied to benefits that are elected prior to someone’sFull Retirement Age (FRA), which results in a reduced benefit. It’s not necessarily the case that a reduced benefit is a problem, nor is it necessarily obvious that it is a problem, when it actually is.
At least part of what explains why this problem can be inconspicuous is the focus that someplace on receiving a benefit, any benefit, from Social Security, as opposed to the best one. In other words, receiving a Social Security benefit is the exclusive, or at least a primary, condition that dictates whether we are proceeding correctly with our plan. That singular focus is compounded by the fact that the depletion of investments that results from receiving benefits too early is a slow process that occurs over a relatively long period of time—kind of like erosion.
In my experience, someone having elected, or planning to elect, benefits too late is a rarity. This is because the person who has arrived at such a decision on their own is typically savvy enough to know that they need to keep a pulse on when they should elect to receive benefits. Alternatively, if they have worked with an advisor, then chances are good that the advisor is ensuring that strategies are monitored. By the way, yes, this means that the strategy that appears to be the best can change as conditions change, particularly as the value of investments changes and impacts the strain placed on them by withdrawals.
One thing that should be understood about this discussion of Social Security benefits is that deferring benefits is, and should be, the default. In other words, it should be assumed that deferring is the best strategy unless you have specific analysis or reasons that dictate a different strategy to be best. The simple reason for this is the lack of flexibility described above. In other words, electing benefits cannot be undone, outside of a relatively short window of time; whereas not having elected benefits can be undone, so to speak, by just applying for benefits.
What all of this simply means is that the risk of electing too late is only more significant and enduring, if allowed to endure. Therefore, if we assume that all folks who defer benefits are diligent about the ongoing monitoring of Social Security strategies, then that means those who elect to receive benefits too early are the ones left with the greatest risk of not electing the best strategy.
When it comes to an early election of benefits, it's been my experience that there are three mindsets that lead to that decision. In the next piece, we're going to look at the Simple Sloth, Early Bird, and Worker Bee.