Is Delaying Social Security Still Smart?
How volatile markets and concerns over the program's finances should affect claiming decisions for pre-retirees and early retirees.
Note: This article is part of Morningstar.com's 2020 special report, "Are You Able to Retire?" A version of this article originally published in April 2020.
Among financial planning cognoscenti, the standard advice for Social Security is to delay filing past full retirement age for as long as you possibly can in an effort to enlarge your eventual benefit. After all, you can increase your benefit for each year you wait past full retirement age up until age 70. Moreover, the enlarged benefit you get is a guaranteed lifetime benefit. That's impossible to beat with other guaranteed investments, especially given today's miserly yields on cash and high-quality bonds. That benefit can also be valuable to a surviving spouse, in that the spousal benefit he or she eventually receives will also be larger (provided the surviving spouse isn't claiming on his/her own work record).
But is the advice to delay still sound amid the current coronavirus crisis and market drop? After all, the pandemic has introduced some new challenges, both for investor portfolios and arguably for the program itself.
For one thing, while the stock market has recovered nicely since its first-quarter swoon, it's by no means a given that volatility won't return. And if it does, many new retirees might prefer to forestall portfolio withdrawals, especially if they don't have enough in safe assets to draw upon instead. If that's their predicament, would they be better off getting the cash they need from Social Security now, thus giving their retirement portfolios time to heal?
Additionally, many individuals may well be concerned about Social Security itself. Of course, concerns over the program's ability to pay promised benefits have been around for a long while, but they're heightened given the federal spending that has been unleashed to alleviate the economic downturn brought on by the coronavirus pandemic.
Is Delayed Filing Still a Good Option?
Let's start with the investment portfolio question. Some investors hesitate to delay Social Security because starting benefits sooner can keep more of their money working in the market.
But Morningstar Investment Management's head of retirement research David Blanchett argues that stocks are still likely to underperform the 8% annual benefits pickup you gain by delaying Social Security. "I don't think it's going to be possible to beat delaying claiming Social Security with equities for the average person today, and that ignores the fact there is significant risk in equity investing, but Social Security benefits are guaranteed."
Indeed, he argues that stocks aren't the right point of comparison for Social Security claiming in the first place. Because the benefits enhancement of delayed filing is guaranteed, the best point of comparison would be safe investments like cash and bonds, whose yields have been depressed by the Federal Reserve's actions and the ongoing flight to quality. "Now that interest rates are lower it means the benefits associated with delaying claiming are even greater," he explained, "Social Security is technically a better 'deal' now than it was a year ago."
Of course, there can be good reasons to expedite Social Security filing, especially for those who are forecasting shorter-than-average life expectancies because of health conditions or for people who truly have no other sources of funds for living expenses. But Sue Stevens, a wealth advisor at Buckingham Strategic Wealth, believes that Social Security claiming decisions should be multifaceted. "When we run our retirement projections, we build in stress-testing that includes both larger drops in the market and higher inflation. You have to look at individual circumstances to find the right combination of ages for a couple to start taking Social Security. But in most of the cases we see, it's still better to delay," she said.
What Are the Other Levers?
But what if the market takes another big drop and an investor's equity-heavy portfolio takes a tumble along with it? Even if most individuals would be better off delaying Social Security to enlarge their eventual benefits, might someone with a very risky portfolio that has dropped a lot be better off claiming Social Security now if the choice is to invade equity assets after they've fallen?
Blanchett doesn't think so. "People sometimes try to invest their way out of a retirement shortfall since stocks tend to outperform bonds, but what we've just experienced [in the first quarter of 2020] is an example of why this is a bad idea. That's especially true because market drops are also associated with negative economic events like layoffs."
Stevens said that she and her team look to other levers to forestall withdrawals from a portfolio when it's in a trough, thereby preserving delayed Social Security claiming as an option."We would talk about possibly pushing out the retirement date or exploring part-time work if either of those were possibilities. We would also talk through how much the client hoped to spend in retirement or in the years leading up to retirement. It's all about trade-offs," she said.
She also said that a reverse mortgage may be an answer in some situations, but cautions that the costs and age limit (62) are also considerations. Tapping reverse mortgages amid weak markets was a topic that financial planners Harold Evensky and John Salter explored in their research nearly a decade ago.
Moreover, it goes without saying that proper portfolio positioning can help pre-retirees and early retirees maintain flexibility amid volatile markets. That's the thinking behind the bucket approach to retirement portfolio planning. Cash and high-quality bonds provide a buffer to help ensure that a retiree won't need to invade the portfolio when it's in a trough.
Stevens says she and her team maintain an allocation to safer investments for precisely situations like the present. "Most of our clients' portfolios are balanced between stocks and bonds," she noted. "Not only can we pull cash they need from the bond side of the portfolio, but we can also do things like turn off dividend reinvestment on the stock side to generate more cash flow if that's in the clients' best interest. We also think about clients' cash flow needs so that any money needed for the short term is placed in an accessible investment that is 'ready to go' when the client needs that cash."
But What About the Program Itself?
Finally, in addition to portfolio and market considerations, some investors who had been planning to delay Social Security filing might be feeling more anxious about the health of the program itself. Is there a chance that Social Security benefits could change while they wait?
The annual Social Security and Medicare Trustees Report, released last week, indicated that the Social Security trust fund will be exhausted by 2034, barring changes to the program.
At the same time, it's worth noting that the fund only covers about a fourth of the cost of the Social Security program; the bulk of the funds come through payroll taxes. Thus, even if the trust fund runs out, that would only jeopardize a portion of promised benefits. Thus, it's a mistake to assume that Social Security benefits will go to zero.
Nonetheless, it's only reasonable to acknowledge that the current pandemic and its implications for the economy and jobs may well have some impact on Social Security's funded status. After all, the aforementioned trustees' report didn't factor in any of the economic challenges that have been brought on by the pandemic.
But Morningstar contributor and author Mark Miller argues that the recent concern about Social Security's financial health is nothing new. "It's been out there for quite a while, fueled partly by the nonstop talk about the program's long-range financial shortfall. That's a real problem, but a manageable one, and it is not related to the spending the government is doing now to offset the economic devastation being caused by the pandemic," he said.
Stevens believes that, as always, the Social Security filing decision should be viewed as part of a broader mosaic of retirement funding. "We look at Social Security as one part of several sources of income during retirement. We want to look at these sources in combination to find the best mix of portfolio withdrawals, pension payments, annuity options, and other sources like rental income or part-time employment. The tax implications of those income sources should be very thoughtfully weighed," she advised.