08/20/2010 01:18 pm ET Updated May 25, 2011

Doing the Math on Early Social Security Benefits

A recent column on how to maximize your Social Security benefits inspired some readers to fire up their spreadsheet programs.

The column was excerpted from my book, The Hard Times Guide to Retirement Security. It delivered this message: most -- but not all -- Americans will do better over the long haul by waiting until full retirement age to file for Social Security benefits.

This message is tough for some to accept. Why wait until age 66 to get something that you can take at age 62?

Here's the core of my argument: For most people, filing early at 62 is a costly mistake that will mean forgoing thousands of dollars in lifetime benefits -- in some cases, hundreds of thousands. Although you can file for benefits at 62, most of us will receive larger lifetime payouts by waiting, if at all possible, until we reach age 66, or even 70. However, there are several caveats to this, and it's a bit of a gamble, because the math all depends on how long you live.

Under the Social Security rules, your lifetime benefits will be reduced based on an actuarial projection of your longevity, if you file before the current full retirement age of 66. Starting at 62 means you retired four years early, the net effect: Your annual benefits will be reduced permanently by a total of 25 percent.

OK, readers -- fire up your spreadsheets!

"I don't believe that your recent advice to delay receiving Social Security payments in order to get a higher monthly amount adds up," wrote Barry, a reader in the New York area. "The Social Security system is based on actuarial principles, therefore it is designed to pay out the same amount (for persons having the same wage history) no matter when they decide to collect. Thus there is no automatic windfall to be gained by waiting."

Barry goes on to construct a scenario (too lengthy and elaborate to reprint here), in which a 62-year-old person files for Social Security, invests it until full retirement age and comes out ahead at age 66 -- assuming a 3 percent annual return, and leaving out income taxes for simplification purposes.

"A rough calculation shows that by the time this person has reached the age of 66, he will have $50,600 in the bank as a result of the payments plus interest. The person who is waiting has nothing. This means that the first person has a substantial nest egg which he can use for emergencies or for things like vacations, cars, house improvements, gifts to grandkids, etc."

"My main point is that it is better to start collecting when you are first eligible (assuming you are not still working) because you accumulate a substantial nest egg plus you have money available when you are still young enough to really appreciate it."

Barry assumes that people actually will save this money rather than spend it. I'm not so sure, given human nature and our collective rocky record as savers. I also question the rate-of-return assumption, since we don't want to invest Social Security money in the stock market or anything else that is risky. We'd need to park the Social Security payments at regular intervals in risk-free certificates of deposit, and current six-month CDs yield less than 1 percent.

All that aside, I don't mean to suggest that waiting to file is right for everyone. It can make sense to file at 62 if you're in poor health and don't expect to live long. Likewise, take benefits early if, due to the recession, you're in desperate financial shape and must have the money now.

And Barry is correct to point out that Social Security benefits are designed to be actuarially fair, assuming average life expectancy. But the system is based on averages that many people will beat. Research by the Center for Retirement Research at Boston College (CRR) suggests that the "break-even" age is 81 -- if you live past that age, you'll receive greater lifetime benefits by waiting until your full retirement age.

"Many people live longer than average and it is especially likely that one member of a couple will live longer than average," says CRR's Andrew Eschtruth. "For example, if the husband is the primary earner, he may die at the average age but his wife may live at least several years longer. If so, she would get her husband's larger benefit rather than her smaller spousal benefit."

On the other hand, higher survivor benefits can be one reason for a married woman to file early. CRR's research suggests that if a woman's own earnings will yield a benefit ranging between 40 percent and 100 percent of the husband's, she should claim benefits as early as possible. If the husband waits until age 69 to file, the woman will receive the maximum lifetime benefits by filing early and then receiving the higher survivor benefit upon the husband's death.

Further reading

For those who would like to dig further into the weeds on this subject -- or keep plugging data into their spreadsheets, here are two key studies from the Center for Retirement Research well worth reading.

Why Do Women Claim Social Security So Early? If individuals continue to withdraw completely from the labor force in their early 60s, a large and growing number will be hard pressed to maintain an adequate standard of living throughout retirement. Economic and demographic pressures are gradually eroding key sources of retirement income at the same time that increases in life expectancy mean that people can expect to live for 20 years, on average, after they stop working. And averages do not tell the whole story.

When Should Married Men Claim Social Security? Most married men claim Social Security benefits at age 62 or 63, well short of the age that maximizes the expected present value of the average household's benefits. That many married men "leave money on the table" is surprising. It is also problematic.