In many countries, especially in the West, an increasing number of people are choosing to retire before they start claiming Social Security benefits. While many assume that a person’s retirement age coincides with the age they begin receiving Social Security, in reality, there is often a gap between the two. A survey conducted in 2024 revealed that while most people retire around 62, they typically wait until 65 to start claiming Social Security benefits. This means that many retirees face a gap of at least three years where they have no income from Social Security and must rely solely on their savings. If not properly planned for, this transitional period could become the defining risk of their entire retirement. For some, this gap may last even longer, and how they manage it directly impacts the stability and longevity of their retirement finances.
Consider Susan, for example. She plans to retire at age 60, but she intends to wait until she is 65 to start claiming Social Security, which she estimates will provide her with $25,000 per year. Until then, she calculates that she will need $60,000 annually to maintain a comfortable lifestyle. She plans to withdraw roughly 6% annually from her $1 million 401(k) balance. Her 401(k) is entirely invested in low-cost index funds that track the S&P 500. Given that the S&P 500 has historically delivered an average annual return of 10% since 1957, according to SmartAsset, Susan feels confident in her strategy.
Unfortunately, Susan is not so lucky. During her five-year gap before claiming Social Security, she experiences a severe bear market. The S&P 500 drops 10% in the first two years, followed by three years of flat market performance. By the end of this painful period, Susan’s 401(k) balance has been cut nearly in half, leaving her with just $527,400. Withdrawing 6% annually from this diminished balance would mean depleting over 10% of her savings each year. If the market stays sluggish or inflation rises, she could find her 401(k) depleted years earlier than planned, leaving her with only Social Security benefits to rely on.
This scenario highlights the very real risks that come with retiring before claiming Social Security. The gap between the two can become a financial chasm if not carefully planned for. Without an adequate strategy to bridge this gap, retirees risk watching their savings dwindle far faster than they anticipated, potentially jeopardizing the stability of their entire retirement.
One solution to this challenge is what financial experts refer to as a “financial bridge.” In simple terms, this means creating a pool of safer, more stable assets that can be drawn upon during the gap years before Social Security benefits begin. Without the income from work or Social Security during these years, retirees’ personal finances are especially vulnerable. In Susan’s case, the biggest risk came from having her entire nest egg invested in volatile stocks during a market downturn.
To mitigate this risk, Susan could have earmarked a portion of her savings—let’s say $300,000 of her $1 million portfolio—for safer, fixed-income investments like bonds, which typically provide a 5% annual return. Had she done this, even with the same poor market performance, her portfolio would have shrunk to about $601,800 by the end of the five years—only 14% less than the original amount. By adding this “bridge,” she could have preserved more of her wealth, allowing her to weather the market downturn more comfortably.
Of course, this strategy comes with trade-offs. If the stock market performs better than expected during those years, a more conservative approach would miss out on potential gains. However, for retirees who prioritize stability and whose risk tolerance decreases as they near or enter retirement, shifting part of their portfolio into bonds, Treasuries, or other lower-volatility assets could provide greater peace of mind.
As a general rule of thumb, many financial advisors suggest that individuals should gradually reduce the risk level of their investment portfolios as they approach retirement, regardless of whether they are facing a gap between retirement and Social Security. For retirees, especially those who are no longer receiving an income from work, protecting the wealth they have accumulated becomes a priority. Ensuring that their savings are not subject to excessive volatility during this crucial period can help avoid the risk of outliving their funds.
Planning for the years between retirement and Social Security is not just about covering living expenses; it’s also about protecting the savings that will support you for the rest of your life. The stronger your bridge during this period, the more securely you can transition into the next phase of your retirement.
In practice, many investors are reluctant to shift a significant portion of their savings into lower-risk investments as they near retirement, as they often seek higher returns through more aggressive investments. However, as individuals get closer to retirement, their ability to tolerate risk decreases. Therefore, the ideal strategy is to gradually adjust the portfolio, especially as retirement nears, reducing exposure to high-risk investments and increasing the allocation to more stable, income-generating assets. This shift can help ensure that retirees’ funds remain secure during the transition.
In conclusion, retiring before claiming Social Security presents a significant challenge for many individuals. Without proper planning, the gap between retirement and Social Security can quickly become a financial liability. However, by carefully managing assets during this transitional period—such as by using a financial bridge strategy—retirees can minimize the impact of market volatility and safeguard their long-term financial health. With the right approach, it’s possible to navigate the gap with confidence, ensuring a steady income stream that lasts throughout retirement.