Many Americans tend to think of Social Security the same way they think a bout retirement plan contributions. This is understandable, given that we pay FICA taxes with each paycheck, with the expectation that there will be Social Security income waiting for us once we hit retirement. It feels remarkably like the way you set money aside with each paycheck as a contribution into a 401(k) or IRA.
But thinking of Social Security as a retirement investment isn’t just a mental shortcut, it’s a psychological way of viewing the program, and it can lead to some irrational and expensive decisions about your benefits. Here’s how:
Social Security and the Break-Even Analysis
When you put money in an investment, you want to maximize the return on your investment. When it comes to Social Security, this natural preference for maximization of your investment leads to the fear that you might end up subsidizing someone else’s retirement without seeing the benefits for yourself.
Because of this fear, many beneficiaries consider things like the break-even analysis to help them figure out how to maximize their lifetime payout from Social Security. This analysis calculates how long it would take for you to break even if you compare your lifetime payout from taking earlier, lower payments, compared to the payout from later, larger payments.
For instance, Oliver, Anjan, and Geraldine are each eligible for a monthly benefit of $1,000 at full retirement age.
- Oliver decides to take benefits at age 62, meaning his monthly benefit is reduced to $733 and he will receive $8,796 annually.
- Anjan waits for his full retirement age, and receives a benefit of $1,000 per month or $12,000 per year.
- Geraldine waits until she turns 70, and receives a benefit of $1,293 per month, for an annual total of $15,516.
Their break-even analysis would look like the following (not including annual COLA):
| Age | Oliver’s Lifetime Payout | Anjan’s Lifetime Payout | Geraldine’s Lifetime Payout | Who Has Collected the Most? |
| 62 | $8,796 | $0 | $0 | Oliver +$8,796 |
| 66 | $43,980 | $12,000 | $0 | Oliver +$31,980 |
| 75 | $123,144 | $120,000 | $93,096 | Oliver +$3,144 |
| 77 | $140,736 | $144,000 | $124,128 | Anjan +$3,264 |
| 80 | $167,124 | $180,000 | $170,676 | Anjan +$9,324 |
| 82 | $184,716 | $204,000 | $201,708 | Anjan +$2,292 |
| 85 | $211,104 | $240,000 | $248,256 | Geraldine +$8,256 |
If you consider Social Security to be an investment, you might decide that Oliver has the right idea in taking his benefits as soon as he is eligible. It will take Anjan until nearly age 77 for his total lifetime benefits to catch up for the four years of benefits Oliver received between age 62 and full retirement age, and it will take Geraldine until age 80 to break even with Oliver.
The Downside of Investment Thinking
There are a couple of problems with trying to get the best return on your Social Security investment. The first is the fact that the only way to “win” the break-even analysis is to die before reaching age 77 or 80. That hardly feels like a responsible way of planning for your future.
In addition, the risk of falling into poverty grows as you age, and accepting a lower monthly benefit can limit your ability to handle financial issues as you age. Though it seems like Oliver will be “ahead” by nearly $32,000 in the first four years in the above break-even analysis, this does not accurately represent what living on his benefits would look like. A monthly benefit of $733 does not have much purchasing power at any age, but it can be especially difficult for an older beneficiary to make do on that amount because of the cost of healthcare.
According to a 2004 health services research study on lifetime distribution of healthcare, nearly half of lifetime healthcare expenditures occur from age 65 onward. It’s far easier for workers in their early sixties to continue working or find ways to live on less than it is for older retirees to try to stretch a fixed income to pay for expensive medical care.
Try an Insurance Mindset
While the investment mindset can prompt you to attempt to maximize your Social Security benefits, considering your Social Security benefits to be a type of insurance can give you a more rational way of determining the best strategy for taking those benefits.
The insurance mindset takes the break-even analysis off the table, in the same way that you would never use the break-even analysis to determine if your homeowner’s insurance policy is a good deal. Though you pay an annual premium to your insurer for your homeowner’s policy, you probably hope to never have a claim, even though that would mean you “lost out” on the investment of all those premiums. That’s because we don’t purchase insurance to make a profit, but to protect ourselves from catastrophe.
Your Social Security benefits can also help to protect you from the catastrophe of outliving your savings. While that might not be as dramatic or immediate as the fire or tornado that your homeowner’s insurance protects you from, it is a major financial problem nonetheless. Aging without enough money to live on causes stress and forces you to make incredibly difficult decisions.
If you learn to think of Social Security as a type of insurance, that can help you recognize that you need to maximize your protection (i.e., your monthly benefit) rather than your profit (your lifetime payout).
Protect Yourself
Delaying your Social Security benefits is one of the best ways to protect yourself from the possibility of an impoverished old age. Treating Social Security more like insurance than an investment can help you to remember that your total lifetime payout is far less important than having an adequate monthly benefit to see you through your golden years.
Steven C. Johnson, ChFC, is a financial planner with Finivi. Over nearly 30 years, Steve has helped many clients maximize their Social Security retirement income benefits. Steve is a well sought out speaker for numerous private and public corporations, educational institutions, and social and fraternal organizations on the topics of Social Security and Retirement Income Planning. Would you like to educate your employees about Social Security claiming practices? You can schedule a complimentary consultation online or by emailing info@finivi.com.
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This information is not intended to be legal or tax advice. The author can provide information, but not advice related to social security benefits. Clients should seek guidance from the Social Security Administration regarding their particular situation. Social Security benefit payout rates can and will change at the sole discretion of the Social Security Administration. For more information, please consult a local Social Security Administration office, or visit www.ssa.gov.
