Social Security/Pension Commencement Analysis

John A. Kvale CFA, CFP®


Determining the Best Time to Begin Drawing Social Security or Pension Benefits
In this article we discuss an important irreversible decision everyone must make.  We have included a graphical view of our proprietary internal model to help clarify our discussion.  

We want to begin our discussion by again reminding readers that every situation is different and our discussion is not meant as a recommendation to begin your pension benefits without further analysis.

Confusion often arises when determining the commencement date for fixed income benefits. Our definition of fixed income benefits are the irreversible election of a benefit for the beneficiary’s life and his or her co-beneficiary.

The most common fixed income decision everyone must make, is when to begin social security benefits.  For those readers lucky enough to have a pension from an employer, or prior employer, your decision is much more complicated, and should be carefully reviewed.

Key benefits for pension beneficiary’s to review before electing permanent benefits are as follows:

Beneficiary death benefit: Generally under current interest rate environments we like full survivor benefit or 100% spousal benefits in the event of the primary beneficiary’s death.  This is not always the case, and careful analysis is necessary to confirm this election.

Cost of Living Adjustment:  This term is used to describe the increasing annual benefit associated with an inflation adjustment which is most commonly tied to CPI (Consumer Price Index.)

Commencement date: This is the subject of our article, and also the most important decision you will make concerning permanent benefits such as Social Security and Pension.

We have developed an internal visual model to help clarify the long term break even effects timing decisions make for pensions and Social Security benefits.

The following models are results from a very specific case, and are using only Social Security benefits as an example.  Remember this is generally a very permanent decision and should be carefully reviewed prior to commencement.

The following models on the next several pages assume our beneficiary is currently 60 years old and will be eligible for maximum social security benefits when he or she begins drawing benefits.  Our example beneficiary does not expect to earn W-2 or salaried 1099 income in excess of his or her maximum at early retirement age.  The maximum earnings amount for 2007 for a beneficiary who is taking EARLY social security benefits is $12,960.  Please note this is for a beneficiary taking EARLY benefits, and this maximum amount is EARNED income from an employer or company.  Interest income and other retirement benefits do not count towards this cap.  One dollar will be withheld for every two dollars earned in excess of this cap for our early retirement beneficiary. For beneficiarys at full retirement age, 66 in our example, there is not limit on earned income.

We have also assumed that having money in your pocket today is worth 4%. Having money today has a value and that value is different to everyone.  For some people this may be too low, or others too high, but we feel this is a conservative number and should be at least realistic for most.

Our last assumption is that your tax rate does not change.  Keep in mind tax rates are at historic lows and if they increase over time, which we expect they will, taking early withdraws becomes more advantageous.

Lastly, the lightening rod that we must mention, is the possibility of changed or lesser benefits in the future.  Bear in mind there is much talk of lowering the benefits (Social Security and Pension) in the future.  It is highly likely that if benefits are changed, those who are currently taking distributions will be grandfathered.

For confusion sake we have not included the actual numbers, only the breakeven graph for our discussion.

As you will see there are many factors to consider from a rather standard benefit.  Pension benefits usually have multiple options making this decision even more complicated.

Break Even Crossover Graph


Ok, so it’s a nice graph but what does it mean? This graph shows the net difference a beneficiary gains from early withdrawal (Social Security) versus waiting until full retirement age. If at age 62 this individual feels strongly that he or she will live well past age 76 and one half, then he or she may consider waiting until age 66 to begin receiving benefits (all other items being equal i.e. taxes, and legislative changes.) 
Notice the graph rises sharply until age 66, and then begins a downward slope towards zero crossing the break-even point at age 76 and one half.  By taking early benefits, our sample person receives money for four years prior than if he or she had waited until age 66. But, if he or she had waited until age 66, our sample person would begin receiving greater benefits at age 66, thereby lowering the net early gained benefit. For our sample person this decision breaks even 14 and one half years after he or she begins early benefits.

We are not trying to make a decision or sway anyone in a direction, we are only trying to analytically present the facts in a simple form for everyone to understand the benefits and drawbacks of early benefit elections.  


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