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Why claiming Social Security is really just a gamble

The Motley Fool logo The Motley Fool 2/12/2020 Maurie Backman

One of the most difficult retirement decisions you'll have to make is choosing when to file for Social Security. Though your benefits are calculated based on your lifetime earnings, you're not entitled to your full monthly benefit until you reach full retirement age, or FRA. Here's what FRA looks like, depending on when you were born:

Year of Birth

Full Retirement Age

1943-1954

66

1955

66 and 2 months

1956

66 and 4 months

1957

66 and 6 months

1958

66 and 8 months

1959

66 and 10 months

1960 or later

67

DATA SOURCE: SOCIAL SECURITY ADMINISTRATION.

That said, you're allowed to sign up for Social Security as early as age 62, but for each month you claim benefits ahead of FRA, they'll be reduced by a certain percentage. And on the flipside, you can also delay benefits past FRA, boosting them by 8% a year in the process up until you turn 70, at which point that incentive expires.

Clearly, there are consequences to claiming benefits at different ages, though interestingly enough, if you live an average lifespan, there really shouldn't be. That's because in that situation, Social Security is technically designed to pay you the same lifetime total regardless of when you initially file.

Here's how that's possible: When you file for benefits ahead of FRA, you get less money each month, but you also get a larger number of individual payments so that if you live an average lifespan, it all works out. And the reverse holds true as well. Delaying your benefits will give you more money on a monthly basis, but fewer individual payments to collect.

Related video: How the age you retire changes your Social Security benefits (provided by CNBC)

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But here's when that break-even formula doesn't apply: when you're likely to pass away at a young age or outlive the typical senior. And that's why, to a large extent, filing for Social Security is really nothing more than one giant gamble.

Can you predict the future?

As a general rule, if you expect to pass away on the young side, you'd be wise to claim Social Security early to collect the maximum amount of money in your lifetime. And if you expect to live a long life, delaying your benefits as long as possible makes financial sense.

Case in point: If you're entitled to a monthly benefit of $1,500 at an FRA of 67, and you file at 62, you'll shrink each payment you collect to $1,050, but you'll collect 60 more individual payments. If you pass away at age 73, which is relatively young (over a decade earlier than average life expectancy for today's 65-year-olds), you'll end up with more than $30,000 extra in lifetime Social Security income by filing at 62 rather than waiting until FRA.

Now let's take that same $1,500 benefit but assume you delay your filing until age 70. Doing so will give you $1,860 a month, but with 36 fewer lifetime payments. If you live until 90, which is about half a decade longer than the typical senior is expected to, you'll come out over $32,000 ahead by delaying benefits instead of claiming them at 67.

Based on all of this, you'd think the formula for deciding when to claim benefits would be simple: If your health is poor, file early. If your health is great, file as late as possible.

The problem, however, is that none of us can predict the future. You might enter retirement in bad health but make lifestyle changes that lead to a much-improved outlook a few years down the line. Or, science might come up with a treatment or cure for the disease that's supposedly cutting your life expectancy short.

The same holds true if your health is great and you have a strong family history of longevity. You could suddenly get diagnosed with a disease that you're the first in your family to get, thereby causing you to pass away much sooner than any doctor would've predicted prior to that diagnosis.

As such, claiming Social Security really is, to a large degree, a gamble, since you don't know how long you're going to live. And since that's the case, often, the best you can do is make an educated guess based on your health, and life's other circumstances as well. For example, if you're low on savings going into retirement and have no reason to believe you won't live a long life, then delaying benefits makes a lot of sense. Or, if you're laid off from your job in your early 60s and don't manage to find another one, claiming benefits early is smart if you need them to pay the bills.

What's the right call?

When it comes to signing up for Social Security, there's really no right or wrong answer. The best you can do, therefore, is make sure your health is a major factor -- but by no means the only factor -- in your decision.

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