Using TSP Funds vs Social Security

“Your TSP is an asset that can be given to future generations and your social security income is not. As the condition of social security worsens, why is it not a good idea to conserve your willable assets and start drawing social security income at age 62?” – Jeff

Jeff, this is a great question and one that we work a lot on with our financial planning clients in the retirement planning process.

We have a lot of conversations with Federal Employees about when is the most appropriate time for them to start Social Security. There are always two sides to this coin: math and emotion.

What we find is that many Federal Employees ask us the mathematical question based on the emotional fear about the status of social security.

Will Social Security Exist When I Retire as a Federal Employee?

“The government giveth and the government taketh and all with the stroke of a pen.”

President Roosevelt signed the Social Security Act in August of 1935. Thus taking a percentage of wages from workers and putting them into a pot meant to provide a pension income when they retired. In 1935, there was an average of around 37 workers for every 1 retiree.

Life expectancy at birth in the 1930’s was age 58 for men and age 62 for women. The average retirement age was 65 years old.

Life expectancy today is well into the late 80s for both men and women. Retirement age remains on average age 65.

Yes, this is a problem.

However, this is a problem for more future generations regrettably. For those looking to retire today – your social security benefits will probably not be impacted. Congress has been rather consisitent about this though they are mentioning reform for other generations.

Social Security has to be reformed and we believe that it will be.

If you were born prior to 1981 I don’t think the changes that social security will make are going to impact you. For the most part, you will probably continue to receive benefits as they are received by people you know today.

If you are born after 1981 then I think some changes will be in place before you are eligible to draw social security benefits.

The types of changes will be modification to the ages of eligibility as well as an increased wage limits.

The scarcity complex tells us that if we want any of what we put into the system then we better start taking it out just as soon as we are eligible. This is an emotional response. Let’s look at the math and maybe offer a different perspective on how to think about your social security benefits.

TSP vs. Social Security

What if you looked at your social security benefits like a rate of return? It’s not precisely the same. But let’s put a little bit of a spin on how we conventionally think about Social Security benefits.

Age 62 – Reduced Benefits

Here is where most Federal Employees that we work with fall into that scarcity mentality. Yes, you are eligible at age 62 to begin drawing your social security benefits.

However, at a permanent reduction.

That permanent reduction in your social security benefits can be up to a maximum of 30%. For the rest of your life.

Full Retirement Age (FRA)

At your FRA you are eligible to receive 100% of your benefits from social security.

If you are unsure of what your benefits will be or what your FRA is, you can check! We encourage you to log onto your personal account at ssa.gov to find out.

Your most recent social security statement will show you your FRA, earnings history and estimated benefits amount at FRA.

Age 70 – Delayed Social Security Benefits

The maximum age that you can delay taking your social security benefits is age 70.

For every year beyond your FRA that you delayed taking benefits from social security, you received an 8% increase.

Contingent on your FRA, you could delay your benefits until age 70 and receive 132% of your benefits.

“Rates of Return” a Different Perspective

Think or maybe even “re-think” how you feel about starting social security early or delaying social security.

Which would you rather say to yourself,

“I am going to lock in a negative 30% return on my social security benefits and start drawing them at age 62, for the rest of my life.”

or,

“I am going to lock in a 32% rate of return on my benefits by delaying social security, for the rest of my life.”

The rebuttal that we normally receive is, “only if I live long enough”.

Yes. That is true. We can’t predict what age you may live until. That is why we look at a break-even analysis and your personal situation. You may be in a circumstance where your health condition means that we make different decisions.

But if life goes as it should, we hope that you live past age 85.

If you are living past age 85 and began these benefits at age 70, you have been able to reap the benefits for a significant amount of time.

Conversely, your TSP does not have these same types of guarantees. While the asset is will-able through beneficiary designations to your family it is also subjected to market risks.

Likewise, when we work with Federal Employees we use this period of time to do some advantageous tax planning.

For instance, if you’re going to retire from Federal Service at age 65 and delay your social security benefits until age 70 – we have a five years span of time where your taxable income may be significantly reduced.

During this time it may be advantageous to look at converting monies into a ROTH.

When you reach age 70.5 you have to withdrawal from your Tax-Deferred Retirement Accounts a Minimum Required Distribution (RMD). This is a formula based on your life expectancy and assets. These funds when disbursed are taxable.

As a Federal Employee, you have to remember that tax planning is critical in retirement. Do not forget that a significant portion of your pension is taxable, a portion of your social security benefits can be as are any withdrawals from Tax-Deferred Retirement accounts like the Traditional TSP.

Delaying benefits could potentially open a window to do some strategic tax planning in retirement.