Delaying the Start of Social Security Benefits

I was one of the youngest in my 1968 high school graduating class, which means I’m one of the last of those who have already retired to face the decision of starting Social Security payments at our earliest eligibility, age 62. This decision involves many considerations; I advise talking with an experienced financial advisor to help make sure you understand all the ramifications of early retirement.

I was an actuary and understand the mathematics involved in determining the exact retirement age to maximize the present value of Social Security payments. However, that calculation does not include a crucial perspective: reflecting your risk profile relating to outliving your money.

Unfortunately, because you are a single individual the actuarial mathematics of optimizing when to start Social Security doesn’t apply. It relies on the law of large numbers to provide rational results. You and I are single numbers. We only get to die once (reincarnation is not reflected in Social Security earnings records) and you will either die before or after the actuarially expected time—throwing off the results.

A factor people who have significant retirement assets other than Social Security should give significant weight to is the financial effect if you die “too early” compared to the results if you live much longer than anticipated.

Unless you are already living month-to-month (in which case you probably didn’t have significant retirement assets), if you die “too early” you probably didn’t spend all the money you had available. Your beneficiaries will get more than you hoped they would (you hoped you would spend it not your children or church or whatever). You could have lived a bit higher off the hog. That’s your loss.

If you live “too long,” at some point your standard of living takes a rapid decline. In determining how much you can spend each year, you include Social Security, retirement plan payments and dipping into savings based on a reasonable expectation of how long your savings must last. Unless you are lucky enough to have retired from government, your defined benefit plan payments (if any) are not linked to inflation so over time their purchasing power decreases in value. With good planning, you took that into consideration when you determined how much you could pull out of savings each year.

All of which works fine until you live longer than your plan allowed. Savings can no longer hold up its end of the bargain; the pension plan payments buy less and less each year. Only Social Security keeps up with living costs.

By deferring the Social Security payment start until normal retirement age (66-67 depending on your year of birth) you maximize the portion of your assets indexed to inflation. Let’s say your Social Security normal retirement benefit starting at age 66 is $1,000 a month. If you begin payments at age 62, you will receive only $750 a month. Assume inflation runs at 3% every year (that won’t happen, but it could average out to about that). Here’s what you would get at various ages:

Age	With Age 62 Retirement	With Age 66 Retirement		Age	With Age 62 Retirement	With Age 66 Retirement
62	750	0		80	1,277	1,702
65	820	0		85	1,480	1,941
66	844	1,126		90	1,716	2,288
70	950	1,267		95	1,989	2,652
75	1,101	1,469		100	2,306	3,074

During the first four years you are unambiguously better off if you start your Social Security benefits at age 62. Over those four years you will receive around $37,500 in benefits. Assuming a risk-free return equal to the inflation rate, those payments would have an accumulated value of approximately $39,000. You’ll need that money to reimburse yourself for the greater normal retirement benefits you could have been receiving had you delayed your Social Security retirement. Your accumulated pot of money (continuing to grow with interest but shrinking with the make-up payouts) runs out around age 77. From then on you are less well off compared to deferring Social Security retirement.

From a risk standpoint, these later years are just the time you’ll need the extra money because your chances of outliving your life expectancy are now much greater.

For me the choice is easy. I can afford to die “too early” and I won’t be living to regret my decision. However, if I live longer than expected, I’ll have to suffer (or not) the consequences of that decision. Having a larger guaranteed income will be a welcome cushion.

I’m not sure most baby boomers will agree with my logic. The majority of my generation has preferred purchasing perishable consumer goods over saving for retirement. I suspect these people will start collecting Social Security as soon as they can. Many will rue their decision after they’ve run out of money and all they have left are their toys that no longer work.

~ Jim

Personal Budgets, Part 2

Some people I know are paralyzed by not knowing how to go about constructing a budget. You have two large groups of items: money coming in (Income) and money going out (Expenses). Here’s the process that has worked for me.

First, I remind myself that any budget is an estimate, not a perfect prognosticator. Something will happen that I don’t anticipate. Medical expenses are always a variable. Some years I will only have my insurance payments; other years I need additional care. I try to estimate what I expect them to be on average.

I develop only as many categories as I am interested in understanding. Now, I’m a numbers guy, so I like more detail than most people and so have more categories. I suggest starting with a smaller number and increasing them if a category becomes too much of a catchall that it hides necessary information.

For Income, one broad category may be sufficient. However, if your income is variable, you may find it beneficial to track base pay, overtime, bonus and commissions (or whatever forms your compensation takes) separately. If investments are a major source of income, it may deserve its own category.

What Expense categories do I suggest? In alphabetical order:

Automotive
Charitable
Clothing
Entertainment
Food
Housing
Medical
Miscellaneous
Saving
Taxes

You may want to split several of the categories. For example, if you eat out more than once in a blue moon, it probably makes sense to split Food between eating out and eating in. If you are interested in tracking the various components of housing you can have subcategories for utilities, mortgage or rent, insurance, repairs, etc.

If Miscellaneous is too big a percentage, find some subcategories that make sense for your spending.

Notice I listed Savings as an Expense. Savings isn’t a balancing item. Savings should reflect money you invest toward retirement or your children’s education. This includes 401(k) contributions, mutual funds you buy, stocks, bonds, CDs, etc. If you have the money sitting in a checking account that isn’t investing, it’s deferred spending. You haven’t committed to saving that money!

Put down your estimates for each category. If the Expenses add up to more than 100% of Income, you will need to adjust your expenses. Work on this until it feels right. Remember to reflect year specific events, like your daughter’s braces, or the special family reunion you’ve planned.

The best way to keep track of your expenses is to use a software package. There are lots of choices, I happen to use Quicken. My one suggestion is to get the inexpensive version, which will have all you need for budgets. If you decide later on to use the software to keep track of your investments, or make a will or toast your blueberry muffin, you can upgrade later.

Collect your receipts and add them to your software database as often as you can, but no less than once a week. It won’t take much time and they won’t build up to a huge task if you do it frequently.

Many people have trouble remembering what they spend cash on. Two approaches that work are to carry a pocket notebook to record your cash purchases (and then transfer them to you software) or use a debit card, so if you forget to record something your monthly statement from the bank captures them for you.

That should get you started.

~ Jim

Personal Budgets, Part 1

I’m a budgeter. My partner, Jan, is not. Her approach is to allow herself a certain amount of money a month and to spend no more. If an emergency car repair happens then something else has to be deferred a month. That approach would drive me crazy because I would never know exactly where I was going, only where I had been.

We aren’t the extremes – Jan at least knows how much money she has to spend and stays within her limits. My budgets have enough detail to suit my needs, but a CPA wouldn’t be impressed.

Budgeting should be a tool, not a shackle. It should provide guidance, not lock you into an immutable set of decisions. I worked hard to earn my money and it makes sense to me to make sure I don’t fritter it away through inattention.

If you think a budget makes some sense, but you’re not sure how to go about doing it, I’ll give you some suggestions on Friday.

If you are like Jan and think budgets are constraining and you believe you already know where you spend your money, I’d like to suggest you do this experiment for two months. Keep track of everything you spend money on, down to the penny. If at the end of two months when you total up what you spend on each category, if you are not surprised, then I will agree with you that you don’t need a budget—you have an internal mechanism that works for you.

I have some friends who, at the time they did this two-month experiment, were approaching retirement. They paid off their credit cards monthly, contributed to 401(k)s, even had money left over at the end of each month to save. But they weren’t quite sure where their money was going and before they committed to retiring, they thought they should know.

It turned out wine was a much larger percentage of their spending than they expected. Whenever they ate out, which was regularly, they each ordered a glass or two of wine. They had wine most evenings at home—and they weren’t drinking “Two Buck Chuck.” Could they afford the wine? Yes.

When they considered the importance of drinking wine as compared to other things they wanted to do (travel more was one), they realized they could easily cut their wine budget in half and get nearly the same enjoyment from wine and free up money for other things.

I’d be interested in hearing about any discoveries you make.

~ Jim