The Asymmetric Value of Delaying Social Security Benefits

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Despite a compelling body of research arguing that most retirees would benefit by delaying the onset of Social Security payments, the majority who are eligible still elect to begin receiving them as early as possible.  But delaying Social Security benefits is one of the best triple-hedges available to any retiree – simultaneously protecting against poor returns, high inflation, and longevity.

In no small part, the rush to start benefits is attributable to a "take the money and run" mentality among retirees, who don't see the value of delaying as worth the risk of forgoing benefits. And there is a material risk that the retiree will not live to the so-called "breakeven point" when the delay in benefits becomes a net financial positive.

What most retirees fail to recognize, however, is that, while there is a risk to delaying benefits and never fully recovering them, the upside for those who live past the breakeven point isn't just that the money is made back; it's that the retiree can make exponentially more. In fact, these asymmetric results – where the retiree only risks a little by delaying, but stands to gain far more in the long run – are further magnified in situations where the client lives dramatically past life expectancy, experiences high inflation, and/or gets unfavorable portfolio returns – which are, in fact, three of the greatest risks to almost every retiree.

The inspiration for this article is the recent Journal of Financial Planning article entitled "How the Social Security Claiming Decision Affects Portfolio Longevity" by William Meyer and William Reichenstein. Meyer and Reichenstein show how delaying Social Security benefits can increase the overall longevity of a retirement strategy that includes Social Security income and a deaccumulation portfolio.

The impact of delaying 

The primary reason that delaying Social Security can increase the longevity of a portfolio so beneficially is the asymmetric nature of the delay decision.

For example, consider a scenario in which a 66-year-old – currently at full retirement age – with a PIA of $1,000/month chooses to delay benefits by one year, earning a delayed retirement credit of 8%. As a result of the delay, the client will receive a monthly payment of $1,080/month beginning one year from now, at a "cost" of not receiving $1,000/month for the next 12 months. Thus, the client essentially starts out $12,000 in the hole, of which she then gains back $80 each month.

In reality, though, the client recovers the cost of foregone payments slightly more rapidly over time, because the client doesn't merely receive an extra $80/month. The client actually receives $1,080/month, increased by annual cost-of-living adjustments, in lieu of receiving $1,000/month payments now, also increasing by annual COLAs. At the margin, this means the pace of $80/month at which the client is recovering his $12,000 is actually itself is increasing by COLAs each year.

How delaying compounds over time 

Assuming a moderate 8% growth rate on the available funds (e.g., the $1,000/month collected for the first year, compared to the extra $80/month for the client who delays for a year) and a 3% annual COLA, the chart below reveals that it takes just over 20 years for the client to come out ahead due to the decision to delay.

Economic Gain/Loss of delaying1 year past FRA