How Claiming Social Security Early Destroys Client Wealth

Misestimating the age at which Social Security benefits exceed foregone earnings will cost clients tens or even hundreds of thousands of dollars in retirement wealth for at least three important reasons. A breakeven analysis does not consider the value of income in the more distant future. Future income is more valuable in a low-yield environment to higher-income clients who are more likely to be alive. It frames the failure to recover foregone benefits as a loss, which could trigger an emotional client response that favors early claiming. Third, it forces clients to estimate their own longevity – which many Americans cannot do.

The failure to maximize the net present value of Social Security income is the equivalent of a loss in retirement wealth. Claiming too early is economically equivalent to delaying claiming, withdrawing $100,000 from a portfolio, and setting it on fire. Claiming at a suboptimal age will result in less money to spend in retirement and less wealth passed on to beneficiaries.

Pricing annuities: Expected longevity and interest rates

Delayed claiming of Social Security income benefits is a decision to forgo a year of income to receive more income every year in the future. Delayed benefits are an investment. A 67-year-old retiree who gives up $25,000 of income in her 67th year will receive an additional $2,000 in inflation-protected income for life starting at age 68.

If trading a lump sum today for a stream of future income sounds like buying an annuity, it is. This makes it easy to estimate the net present value of delayed claiming by comparing the premium payment to the cost of creating a fairly priced (zero-profit) annuity.

Actuaries need two pieces of information to price an annuity – the expected longevity of annuity buyers and interest rates on bonds that fund future income payments. Annuities are more expensive when interest rates are low and when annuitants live longer. Today, real rates are negative and higher income Americans have gained roughly five years of longevity over the last 20 years.

The 1983 Amendments to the Social Security Act gradually increased full retirement age to 67 for those born in 1960 or later. This created a modest adjustment for anticipated improvements in longevity. But longevity increases have not been uniform among Americans, and this has a big impact on the value of delayed claiming.