Let me offer a different analysis that I think is simpler, yet equivalent to Kitces. It leaves until the end assumptions about inflation rate, tax rate, and rate of return on investment, so that one can decide for oneself whether the risk/reward is worth it.
Really long post. If you don't care at all about the reasoning or calculations, skip to the final three paragraphs, following the clearly marked break (====)Everything that follows is in constant (inflation-adjusted dollars). This removes inflation as a factor (until the end), it removes complex adjustments on SS payments (which remain fixed if measured in constant dollars).
Rather than discuss break even point, I'm going to use average life expectancy. If taking money early and investing comes out better for an average life span (i.e. average for a person reaching age 62), then that's the better path
on average. If deferring the money comes out better for an average life span, then that's the better path.
Finally, what does it mean to come out better? If you take money at age 62, you invest it for four years. Then starting at age 66 (assuming that's FRA, and you are comparing with starting SS at that age), you use some of the invested money to make up the shortfall on your SS checks (you'd be getting larger ones by waiting until age 66). The remainder of the money you keep invested, to grow and to keep making up monthly shortfalls. If you come out with investment money left over when you reach the average life expectancy, you win. Otherwise, deferring (at least until age 66 wins).
The amount of money you have invested each month =
last month's balance * (
1 + montly real rate of return) * (
1 - monthly tax rate).
Let's call this multiplier net real rate of return (NRRoR).
Before age 66, you also add in the amount of the check you get from SS (age 62 monthly check).
After age 66, you subtract the shortfall (age 66 check amount minus age 62 check amount).
I put all this in a spreadsheet. I used $
1000 as the FRA, $750 for the age 62 amount, and $
1320 for the age 70 amount. All after tax values.
The tax rate on SS doesn't matter, so long as it remains constant. You can divide by (
1 - tax rate) to get the SS check amounts.
Here's SSA's
life expectancy table At age 62, a male is expected to live to just short of 82 years of age, on average. Females to age 84.6.
Comparing taking money at age 62 vs. 66, and investing to break even just before age 82, we need to achieve a net real rate of return of 3.0%. (One runs out of investment money about age 8
1 years,
10 months). For females, we need to have that investment last until age 84.6, and that requires a net real rate of return of 4.2%.
Here's where you get to say how good an investor you are. I look at that 3% real rate, and think that one might target a 3% inflation rate, a 7% nominal rate of return (4% real), a
15% annual tax (not completely tax efficient, but taxed on capital gains).
That gets us to 3% net real rate of return.
15% tax on a nominal 7% rate of return bleeds about
1% off of the return. So we have a 4% real return less
1% in taxes, or 3%. To get that 4.2% real return with 3% inflation would require about a 8.5% nominal return (bleeding
1.3% in taxes, leaving 7.2% nominal, or 4.2% real).
That's an admirable target. Now factor in risk, since we're comparing a sure rate of return with SS (i.e. like an interest rate) with a volatile and uncertain market return.
It's a bit better if one compares age 62 with deferring until age 70. Then, you have more years to invest the money before having to make up shortfalls, and fewer shortfall years (only a dozen years until the men die - on average - at age 82).
Now, one needs only a 2% net real rate of return for the average male to come out ahead (money left over after age 8
1,
10 months), and 3% for the women to come out ahead. In other words (assuming 3% inflation,
15% tax annually), 5.75% nominal return for males, 7% nominal for females.
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The bottom line here is that if you've got an average life expectancy, then it looks like you need to be able to invest for around a 7% nominal rate of return with zero risk to do as well as by deferring SS. The more uncertainty there is in achieving this rate of return, the higher that rate needs to be to beat SS on a risk adjusted basis.
It's interesting that people who advocate taking SS early often state that they're taking the "bird in the hand". But when it comes to comparing the certainty of a fixed (real) income stream with the vagaries of the marketplace, they'll go for the uncertain "two in the bush".
That may be a matter of perception - people may feel they don't have control over how long they'll live, but they have control over their investments. I respectfully submit that if anything, the reverse is true. Live a healthy lifestyle, and you can increase your odds of a longer life. But you have no control over the market, which seems to be what has the most effect on how investments perform in general.
