When should you start cashing in on Social Security?

No, I’m not raising this gloomy topic just to be contrarian at a time of widespread celebrations. I’m raising it in Fortune’s Investor’s Guide because one of the most interesting investment decisions that you may have to make (or may have already made) involves estimating how long you’re likely to live.

This decision doesn’t involve stocks or bonds. It involves Social Security retirement benefits.

Here’s the deal, in grossly simplified form, which is the only way to deal with Social Security questions without bogging down. If you’ve got the requisite 10 years of employment (or have been married long enough to someone with the requisite 10 years), you can begin drawing Social Security retirement benefits at any time from ages 62 to 70. The earlier you begin taking money, the less money you get a year. The later you begin, the more you get.

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For example, at 62, you get 75% of your normal retirement benefit. At 66, you get 100%. At 70 it’s 132%. Each year you wait from 62 on increases your benefits by about 8%.

Social Security doesn’t care when you begin taking your money, because people getting lower payments for longer periods cost the system the same as people getting a higher payment for shorter periods. But when you take your money can make a huge difference to you and your survivors, as you’ll see.

There are drawbacks to taking benefits at 62 if you’re employed. I discuss them and the assumptions on which this column is based at the bottom of the page. At 66, however, there are no penalties. That’s when the decision becomes purely economic.

The conventional wisdom is to wait until you’re 70 to draw benefits if you can afford to, because each year you wait increases your payments by about 8% — think of waiting as longevity insurance. If you make it to your mid-eighties or longer, you would do better to wait. The rough math: If instead of getting 100% at 66 you start collecting 132% at 70, it takes 12½ years for that 32% difference to equal the four years of benefits you would have collected starting at 66.

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So if you live to your mid-eighties or longer, you win big. But of course there’s a risk: If you don’t collect anything and die at, say, 69 and 11 months, you (and your survivors) get nothing. It’s what’s known in the insurance biz as mortality risk.

Once you’re 66, it’s hard to give up 8% a year, especially these days. But there’s that pesky mortality risk: Both my parents died in their early seventies. So let me show you the middle path that my wife and I decided to follow. We began to collect Social Security two years ago, when I turned 67. (She’s somewhat younger than I am.) So have we walked away from the prospect of higher income? Not totally.

We’ve been taking our monthly Social Security benefits and investing them, primarily in individual dividend-paying stocks. If we can earn 4% or 5% a year from these investments, it makes up for a good part of the 8% Social Security increase that we’re forgoing. And who knows, maybe we’ll earn even more. Meanwhile, it hedges our mortality risk and leaves our family better off if one or both of us don’t make it to our eighties.

With luck, I’ll be able to write a follow-up column 15 years from now and let you know how our hybrid Social Security strategy has turned out. But in deference to the season, I’ll stop being depressing. Enjoy the year-end lights.

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How it works

If you opt to take retirement benefits at ages 62 through 65 and 11 months, part of your benefit is deferred if you earn more than a certain amount — currently $15,120 a year — from working. Social Security defers one dollar from your benefit for every two dollars you earn above the threshold. The deferred amount goes to increase the benefits that you get starting at age 66 (or, under some circumstances, later).

There’s a second earnings test, far more complicated than the first one, that applies to your earnings in the year that you turn 66. It involves how much you make in the months before your 66^th birthday. I can’t begin to explain it.

However, as long as you wait until you turn 66 (or later) to start taking benefits, neither test will pose a problem.

A further note: I can’t help you straighten out any problems you might have with Social Security or help you understand what rules cover you. Please consult the Social Security Administration or an outside expert for help. This stuff can be very complicated, to say the least.

Here are the Social Security benefits that people born through Dec. 31, 1954 would get, as a percentage of their “primary insurance amount,” by beginning to take retirement payments at ages ranging from 62 (the earliest allowable date) to 70 (the latest date).

Age     Percentage

62        75%
63        80%
64        86.6667%
65        93.3333%
66        100%
67        108%
68        116%
69        124%
70        132%

In my column, I tried to keep things simple by saying that each year after 62 that you wait to collect benefits increases the benefit amounts by about 8%. Please note the “about.” As you can see from the numbers above, it’s not a straight line increase of 8% a year.

These numbers apply only to people born through the end of 1954. There are different numbers for people born in 1955 or later. The normal retirement age rises to 66 and 2 months for people born in 1955 and increases by two months annually until it reaches 67 for people born in 1960 and later.

Note: All the numbers here assume that Social Security’s benefit formula remains unchanged. However, I expect the formula to change at some point for future recipients, and possibly even for current recipients like my wife and me, who are drawing maximum benefits for our category because my employers and I paid maximum Social Security tax for more than 35 years.

Source: Fortune, based on information from the Social Security Administration

A shorter version of this story appeared in the December 23, 2013 issue of Fortune.