Social Security: The Key Mistake Nearly Everyone Makes

Source: SSA Office of the Inspector General.

Social Security is the primary source of income for most retirees in America, and that makes it crucial to make the best decision possible about when to take your Social Security benefits. Yet, the majority of Americans start receiving their monthly Social Security checks within the first year that they're eligible, accepting reduced payouts in exchange for getting them as early as possible.

The trade-off they make is that, while early Social Security makes the early years of retirement a lot more manageable financially, it can put a huge strain on your finances later in life. Although taking Social Security is sometimes the best decision you can make, most Americans make a key mistake in assessing their long-term Social Security needs: they underestimate their own life expectancy.

When positive thinking goes out the windowAmericans are optimistic about many things, but when it comes to making key decisions about their financial planning in retirement, most people are pessimistic about how long they'll live. A study from the Society of Actuaries found that more than 60% of retirees stated life expectancies that were at least two years less than the actual average figures, while only 19% overestimated life expectancies by two years or more. Moreover, the study found that the level of understanding about how an individual's life expectancy can vary from national averages was fairly limited, suggesting that people don't always make ideal choices based on how long they'll live.

The typical argument in favor of taking Social Security early largely hinges on this pessimistic belief about life expectancy. Although some retirees take Social Security early because of financial hardship or their inability to work to full retirement age, many simply believe that the best way to maximize their benefits is to take them as soon as possible. Pointing to figures that suggest break-even dates are in their late 70s or early 80s, these retirees argue that the likelihood of their living long enough to warrant delaying Social Security to get larger payments isn't particularly high.

Claiming later means higher payments, but many don't think they'll live long enough to get them. Source: SSA.

The hard truth about life, death, and Social SecurityWhen you look at the actual data about the age at which people die, you can see just how much people's general pessimism about their life expectancies can lead them to make ill-advised decisions about Social Security. Of the roughly 1.97 million people over the age of 60 who died in 2010, according to the latest data from the Centers for Disease Control and the Census Bureau, almost 1.12 million -- far more than half -- lived until at least 80. The vast majority of those who lived to 80 -- 765,000 -- managed to make it through to age 85 or older.

Data source: National Vital Statistics Reports, Centers for Disease Control.

Certainly, many people do die before reaching average life expectancy. About 170,000 of those who died in 2010 were between ages 60 and 64, and another 190,000 were between 65 and 69. For these people, taking Social Security early was clearly the best choice -- at least from their individual perspectives.

For the 490,000 retirees who died in their 70s, the implications are less clear. Financial planners make a wide variety of assumptions in judging break-even points, making it difficult to draw firm conclusions about whether those in their 70s would have been better off claiming Social Security earlier or later. Those who die in their early 70s would typically get more from claiming early; but by their late 70s, the consequences of making one decision versus the other become relatively small, even if you turn out to have made the wrong choice.

Perhaps, most importantly, the typical break-even analysis fails to take the key area of survivors' benefits into account. If you're single, then the survivors' provisions of Social Security aren't likely to have a major impact on your decision-making process. But for married couples, when you choose to take Social Security can have a dramatic impact on your spouse's benefits after your death. Often, even if waiting to take Social Security would be a bad decision for you individually, it can be the best overall decision for your family if your spouse ends up living long beyond your lifetime.

Before you decide that taking Social Security early is the only real decision for you to make, be sure to consider the long-range implications of your decision on your future finances. Often, choosing to take Social Security later can be the smart move in the long run; you may be able to save yourself from a dire financial fate later in your retirement years.

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