Delayed claiming of Social Security benefits makes overwhelming sense, as do strategies that coordinate claiming by couples. But such strategies are unpopular, despite numerous consumer-finance articles highlighting their advantages. Advisors can add significant value for clients by explaining the benefits of these strategies.
I'll provide a rate-of-return analysis to demonstrate the advantages of delaying Social Security benefits, discuss why individuals and their advisors have failed to adopt the best strategies and highlight a software product that advisors can use when doing Social Security planning with clients.
The basic analysis
Individuals can choose to begin Social Security benefits at any age between 62 and 70. The lifetime benefits payable increase with claiming age. For those born between 1943 and 1954, Social Security defines age 66 as full retirement age (FRA). The benefit for those claiming at 62 is 75% of the age-66 benefit, and the age-70 benefit is 132% of the benefit at 66. The increased benefit for delaying from age 62 to 70 is 76% (132%/75%).
An individual who begins benefits at age 66 in 2014 and has always earned at least the Social Security maximum over a full career would be entitled to a monthly benefit of $2,641. The age-62 and age-70 benefits would be $1,981 and $3,486, respectively. (These figures and other benefit amounts in this article are all in real, inflation-adjusted dollars, because Social Security adjusts for inflation.)
To examine the benefits of delaying from age 62 to 70, we should compare giving up of $1,981 for eight years to receiving an additional $1,505 ($3,486 - $1,981) for the remainder of life. Life expectancy is the critical element in the analysis. We can measure the delay benefit by doing an internal rate-of-return (IRR) analysis with the age-62-to-70 reductions as outflows and the increases after age 70 as inflows lasting for assumed life expectancy.
Returns from Social Security delay
The chart below shows calculated real rates-of-return for males and females based on delaying Social Security from age 62 to age 70 using mortality estimates I developed from a variety of actuarial studies. I estimated average life expectancies for advisory clients, typically more upscale and healthier than the general population, which added about three years to the estimates for the total U.S. that the Social Security Administration provides.
Implied returns from Social Security delay, using estimated client mortality
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Gender
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Life Expectancy (years)
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Implied Real Return
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Premium over 10-year TIPS @ (0.62%)
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Male age 62
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24 to age 86
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3.58%
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2.96%
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Female age 62
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27 to age 89
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4.57%
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3.95%
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Last-to-die M/F
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30 to age 92
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5.24%
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4.62%
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| Source of life expectancy data: Author's estimates |
Because of the inflation adjustments in Social Security, these implied real returns can be compared with yields available in the market for Treasury inflation-protected securities (TIPS). The 10-year TIPS, which are roughly comparable in duration to lifetime retirement benefits for a 70-year-old, provide a real yield after inflation of 0.62% as of late January 2014. We can see that the implied real returns for both males and females are significantly superior to the real yields from TIPS, especially for females, who have a longer life expectancy on average.
I have also included a "Last-to-die M/F" line in the chart, since Social Security provides survivor benefits. If one member of a married couple is both older and the higher earner, and this individual delays Social Security and receives increased benefits, those higher benefits will continue to whichever member of the couple survives longer. So Social Security delay can be particularly advantageous for couples. It may also make sense for couples to use coordinated strategies in which the older/higher earner delays, and the younger/lower earner claims earlier.
When we examine the premium over TIPS-based real yields, particularly for couples, we approach what we might expect for the equity-risk premium of stocks over bonds. With Social Security-delay strategies, it is possible to earn those return premia with lower risk.
So we do, indeed, have a compelling case for Social Security delay for single individuals and especially for the higher-earning spouse in couples.
Some of the articles promoting the advantages of Social Security delay have taken the view that this strategy is akin to purchasing a very attractively priced annuity from Social Security. I utilized this type of approach in a February 2012 Advisor Perspectivesarticle. In November 2013, Tara Siegel Bernard wrote a New York Timesarticle highlighting research by Steve Sass of the Center for Research at Boston College summarized in his issue brief, Should You Buy an Annuity from Social Security? Sass and I independently reached the same conclusion. As he explains, "buying an annuity from Social Security, especially in today's low interest rate environment, is the best deal in town." I have used a different approach in this article that produces the same result by comparing the returns from Social Security delay to returns available from regular investments comparable in risk.
Questions
Although this rate-of-return analysis strongly favors Social Security delay, readers might be left with some questions, which I answer below.
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Why is the government rewarding delay (or penalizing early claiming) instead of applying adjustments that are actuarially fair? The government’s original intent was to provide actuarially fair adjustments, but it has been many years since these factors were updated for changes in interest rates or mortality. Some of these factors were developed in the 1950s. Since 1950, male and female life expectancy at age 50 has increased by six years, as documented in this article. Interest rates are also at historically low levels – real rates that were typically 2-3% are now below 1%. The mortality improvements and lower interest rates have turned adjustments that used to be actuarially fair into strong incentives to delay Social Security benefits.
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Why not use stock/bond mixes rather than TIPS in evaluating Social Security delay? Certainly, the return premium from delaying Social Security would be reduced or eliminated if higher-return investments were used in the comparison. I chose TIPS because they bear the closest resemblance to the cash flows from Social Security delay in terms of risk and inflation protection. This avoids comparing high-risk and low-risk investments and only focusing on return while ignoring the differences in investment risk.
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Isn't there a lot of mortality risk in delaying Social Security? The returns from delaying Social Security by either a single individual or the higher-earning spouse in a couple do indeed depend heavily on how long the single individual (or last to die in a married couple) lives. But whether this is risky depends on framing. If we focus just on the investment, assets like TIPS are less risky. But if we broaden the frame to include lifetime expenses being paid for by the increased Social Security income, the expenses end at death when the additional income ends, so the Social Security delay becomes less risky than funding the same expenses with regular investments. For most retirees, the broader framing is more appropriate.
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What are the return effects for delay periods shorter than from age 62 to age 70? I ran separate tests for one-year delays, which combine to produce the age-62-to-70 returns. The yearly numbers bounced around somewhat, partly because the adjustment factors vary. But for every year, the estimated real return significantly exceeded the current real 10-year TIPS yield. The basic message for healthy individuals (and for couples with at least one healthy member) is that delaying is good and longer delays (up to age 70) are better.
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These numbers are all pre-tax. What happens to the analysis when taxes are considered? The taxability of Social Security benefits is complicated to analyze, due to factors such as the interaction with 401(k) withdrawals, which can cause withdrawals to be effectively taxed substantially higher than the tax-bracket marginal rate. This effect, known as the "tax torpedo," is explained succinctly in this blog post by planner David Beck. As a general rule, tax considerations, although complex, further strengthen the case for delay strategies. If delay makes sense on a before-tax basis, it generally makes more sense after taxes are considered.
Social Security claiming behavior
Given the compelling case for delayed claiming, particularly for the higher earner in couples, we would expect a lot of claiming delayed to age 70. However, this is not the case.
The Urban Institute’s 2013 study, How Did the Great Recession Affect Social Security Claiming?, and the 2012 National Bureau of Economic Research working paper, The Decision to Delay Social Security Benefits: Theory and Evidence, by John Shoven and Sita Slavov, both show that the claiming decision has been closely tied to ceasing work, whereas optimal strategies would separate the retirement and claiming decisions. Charts in both studies show spikes in claiming at age 62 and around the Social Security FRA, currently 66 for those born between 1943 and 1954. The Urban Institute study showed only 5% claiming at age 67 or greater.
We cannot put too much weight on these studies, because they reflect the fact that most Americans do not have enough savings to employ delay strategies. The ideal study would examine people who employ financial advisors, because they typically have more savings and more flexibility. However, a 2012 Wharton study of advisors (reported here by journalist Mary Beth Franklin) showed advisors coming up short in providing guidance on Social Security claiming. In particular, many of the advisors surveyed failed to recognize the value of spousal benefits and the strategy for couples of the higher earner delaying to age 70.
Clearly there is a need for advisors to do a better job helping clients with Social Security claiming decisions.
Improving the advice
Fortunately, resources are available to help advisors do a better job – books, articles and optimization software that provides customized recommendations for clients.
For the past two years, Mary Beth Franklin has been writing a weekly column for Investment News, mostly focused on Social Security strategies. In this column, she listed six books that explain various aspects of Social Security. She also let readers know that she is working on a "new, succinct guide for advisors." Planner Dana Anspach, who writes the Money Over 55 blog, has also been an advocate for improved Social Security planning. In this blog post she provided links to 10 research pieces she has found useful.
My personal favorite source on Social Security claiming strategies is a 2010 paper by Bill Meyer and Bill Reichenstein, Social Security: When to Start Benefits and How to Minimize Longevity Risk, published in the Journal of Financial Planning. The writers packed a huge amount of useful information into a small package and presented it clearly.
It happens that Meyer is founder and managing principal of Social Security Solutions, Inc. He and Reichenstein, his business partner and a professor at Baylor University, built the SSAnalyzer optimization software that advisors can use to help clients. I recently interviewed Meyer and Reichenstein and got a demo of the software, which advisors can preview at their website.
The big advantage of using optimization software is that it tests every possible claiming strategy, which could approach 70,000 for couples, when all the ages and options are considered. The comparison measure used for optimization is the present value of future benefits. As shown in the website materials, SSAnalyzer presents a graph in the form of a "heat map," with the one spouse's life expectancy on the horizontal axis and other spouse's on the vertical axis. For each life expectancy combination, the graph shows the optimal strategy. These strategies can be complex. For example, an optimal strategy might be that the husband files and suspends benefits at age 66, the wife commences spouse benefits at 66 and the husband defers his worker benefit until age 70.
The advantage of the heat map is that it doesn't force clients to pick a single life expectancy as the basis for the strategy choice, but instead illustrates how the best strategy varies as a function of separate life expectancies for a couple. In this way advisors can make well-informed recommendations that properly recognize life-expectancy uncertainty.
In our interview, Reichenstein pointed out that in the current interest-rate environment, the optimal strategies quite clearly point to the older/higher earner in a couple delaying to age 70 and to single individuals in good health delaying to 70. But for couples, the strategy is often less clear for the other spouse. That's where the software's testing the full range of alternatives can be particularly valuable.
Meyer and Reichenstein also made the point that using the software may help overcome behavioral biases against adopting optimal strategies. For example, clients may be reluctant to draw down assets while delaying Social Security benefits. Having an illustration that shows total lifetime benefits for various strategies, customized to client circumstances, can be a major help in overcoming such biases — much more useful in client situations than general comments about the value of delayed claiming.
Conclusion
There is a compelling case to be made for delayed claiming of Social Security benefits and for the adoption of coordinated strategies by couples. Clients and advisors need to break free from thinking about claiming as simply tied to retirement from work. Current advisor capabilities range from excellent (likely with software support) to clueless, and even advisors relying on reasonable rules of thumb may miss the mark. There are too many potential client circumstances and options to consider for such rules of thumb to be reliable. Fortunately, there are resources advisors can use to learn more about Social Security, and optimization software to provide more value for clients. It requires an investment of advisor time and effort, but it's worth it for clients.
Joe Tomlinson, an actuary and financial planner, is managing director ofTomlinson Financial Planning, LLC in Greenville, Maine. His practice focuses on retirement planning. He also does research and writing on financial planning and investment topics.
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