Voices: Ben Hockema, on When Clients Should Take Social Security

Voices is an occasional column that allows wealth managers to address issues of interest to the advisory community. Ben Hockema is a senior financial planner in Illinois.

Many advisers encourage their clients to wait as long as possible to begin collecting Social Security benefits. Typically, the assumption is that the client will live to at least age 82. So the adviser will encourage that individual to wait until age 70 to start collecting, since that will result in the highest total government payout to the client. While this advice is well intentioned, I think this is a misguided way to approach the issue that will lead many clients to make the wrong decision.

Here’s the problem: I have never had a client tell me their goal is to maximize payments from the government. Instead, their objective is to make Social Security decisions that maximize their overall wealth. This distinction is important, because when clients delay collecting benefits, they may need to withdraw more money from their investment portfolios to meet living expenses while they wait. And those withdrawals early in retirement can significantly diminish the clients’ investment returns down the road. Depending on your assumptions, it is very possible that it is best to collect Social Security as early as possible.

Our calculations show a surprisingly large impact with reasonably conservative assumptions about investment returns. If you assume a 5% rate of return on the portfolio, for example, a typical client has to live five additional years–to age 87–before it becomes better to wait until age 70 to start collecting Social Security. The client has to live quite a bit longer for those increased payments to offset the reduction in returns from the portfolio.

Advisers are trying to act responsibly when they encourage clients to wait as long as possible to take Social Security. If investment returns aren’t factored in, the client who waits to age 70 hits break-even at age 82 and continues reaping rewards into their 90s. And so in a sense it is a form of longevity insurance. But if the implication is that at just a 5% rate of return, your break-even moves out to age 87, then the amount of time you will be getting that benefit becomes smaller, as does the risk from taking Social Security early.

Keep in mind that our calculations don’t apply to individuals who have more income than they need, or who adjust their spending to match their income and don’t touch their portfolio principal. Those individuals would be better off following the standard advice to wait, since their collection timing doesn’t have any effect on the size of their portfolio returns.

As an adviser, you have to make sure that you’re asking the right question about Social Security. At a 5% rate of return–which I think is a reasonable assumption–our calculations have led me to advise many clients to start collecting earlier than I had been advising them to do in the past.