Take Social Security early or late? The perennial debating point about retirement needs another look.
For years, the experts have been telling us that delaying benefits to age 70 is a terrific deal. The 24% boost you get from starting at age 70 rather than 67 more than makes up, by a long shot, for forgoing three years of payouts.
Is that really the case? Yes and no. It still pays to wait. But it pays a somewhat disappointing amount.
For a couple, both about to turn 67, the gain from delaying is likely to fall in the range of 1% to 5%. Delay if you can, but don’t feel like a sap for being impatient and starting benefits at the full retirement age of 67.
A few years ago the numbers would have looked very different. The gains from delaying were more dramatic.
What changed? Interest rates. They’ve gone way up. The real (inflation-adjusted) rate on 20-year Treasuries has swung from -0.6% just over five years ago to a recent 2.3%.
High interest rates make dollars delivered in the future worth less. They mean that the extra 24% coming into your pocket down the road isn’t so wonderful.
Let’s say you are just turning 67 and due for a $4,000 monthly benefit, near the maximum. Waiting three years boosts your payout to $4,960. Whatever option you choose, you get annual cost-of-living adjustments that make the benefit constant in purchasing power.
The delay costs you $144,000. It gives you an increment of $11,520 annually for as long as you live. Is this a good deal? Looks that way. Twelve and a half years after starting benefits you have recovered your investment and beyond that the increment is pure profit. You have a very good chance of living to 82-1/2.
But wait. A dollar to be delivered in 2041 is not the same as a dollar you are giving up in 2026. Allow for the time value of money. That 2041 dollar, that bird in the bush, is worth only 72 of today’s cents. Where this calculation came from: the zero-coupon rates built into interest paid on Treasury Inflation Protected Securities, or TIPS.
Why TIPS? Because they pay a real yield, just like Social Security. The ones due in 2041 pay 2%, which means that if inflation averages 3% you collect a nominal 5% but see your purchasing power climb at only a 2% rate. Your right to collect the extra $11,520 a year from Social Security is mathematically equal to a collection of zero-coupon $11,520 TIPS bonds due in future years.
Some people, including some fans of delaying Social Security benefits, neglect to think about interest rates. They’ll just compare the $144,000 to the $11,520, find a break-even point (age 82-1/2), and say that staying alive until that age makes you a winner. That’s faulty accounting. You (or a surviving spouse) have to live well past 2041 to be winners from the delay option.
Some people, including most fans of taking Social Security early, make the opposite mistake. They’ll say they could invest the $144,000 in the stock market and earn a lot more than 2% above inflation. They might indeed do well with stocks, but this is the wrong way to judge whether to start benefits at age 67.
Claiming earlier than at 70 in order to buy stocks means you are in effect reallocating from fixed income into equities. If you want to increase your stock allocation, fine. But do it by making a switch inside your 401(K) or IRA. Evaluate Social Security on its own terms, which means what the $144,000 would do for you if invested in TIPS.
The correct way to evaluate claiming strategies is this: For each future year, calculate the discounted present value of a prospective dollar. Now multiply by the probability you (or a survivor) will be around to get it.
Example: Harry and Wanda are both 67. The probability that at least one of them will be alive at the end of 2051 is 41%. The present value of a dollar delivered that year is 51 cents. When you multiply, you find that their right to collect an incremental dollar 25 years hence is worth only 21 cents now.
It gets complicated. As long as both are alive, Harry and Wanda collect two Social Security payments. When one dies, and it doesn’t matter which one, the benefit is the higher of the two payments. The arithmetic has to separately allow for the probability that both are alive in a given year and the probability that only one is.
I’ve done the calculations for this imaginary couple. I found that delaying improves the expected payout by a modest amount.
Suppose Harry’s benefit at full retirement age is $4,000 and Wanda’s is $2,000. If both claim now, they get an income stream worth $1.21 million. If they both delay, the stream is worth $1.24 million. If Harry delays but Wanda claims now, the stream is worth $1.25 million.
There’s a reason that split timing comes out best. Harry’s $4,960 payout will last for a long time, from 2029 to as long as either one is alive. Wanda’s will last only during the probably much shorter period when both are alive. It doesn’t make sense for Wanda to forgo three years of benefits to get a short-lived 24% boost.
Conclusion: A couple deciding on a claiming strategy should start with a small bias toward delaying the higher of two benefits, then allow other factors to tip them one way or the other.
What about single retirees? The ones in good health get a wealth gain from waiting, but not a great gain. They derive nothing from the valuable survivorship benefit.
Here are four factors to put into the balance.
#1. Do you want longevity insurance?
If you need this coverage, delay.
Longevity insurance is built into the classic, simple annuity that has you getting a fixed monthly payment for as long as you live. Social Security is that kind of annuity.
You get a rotten payback if you die young. In return, you get help paying for groceries at age 98 if you are still around. That’s a trade-off worth making if you aren’t sure your other assets will last to age 98.
By delaying, Harry is investing $144,000 in an inflation-adjusted $11,520 per year joint-life annuity that starts in three years. It’s hard to find products like that commercially.
New York Life, the leading high-credit-quality vendor of simple annuities, doesn’t offer inflation-adjusted ones. It does sell contracts with fixed annual increments, like 3%. If you want additional protection against living too long, consider going to an insurance company—but only after taking advantage of the excellent offering from Social Security.
#2. How’s your health?
If it’s good, lean toward delay.
In the example above, I used the mortality projections published by the Social Security Administration. What if both Harry and Wanda are in excellent health? Make their death rates at any given age equal to 80% of what the government is assuming. That kicks up Harry’s expected remaining lifespan from 17.8 years to 19.7, and Wanda’s from 20.2 to 22.1. Resulting values: $1.29 million for claiming at 67, $1.34 million for the split delay.
If you are reading this article, you probably have above-average health. You are less likely than the average American to be a smoker and more likely to be taking your blood pressure medicine.
#3. How liquid are you?
If you are retired at age 67 and living off savings and pensions, take a look at your budget. Will deferring Social Security force you to cash in assets (like an IRA or appreciated stocks) that carry tax burdens? That makes delay less attractive.
When looking at taxes, include state taxes. New York, California and 33 other states tax some or all investment income and IRA withdrawals but don’t tax Social Security benefits.
#4. Are you worried about socialists?
Social Security is going bust. Its savings account at the U.S. Treasury will run out in 2033 and, absent corrective legislation, it will have to cut benefits.
One way to make the system less insolvent is to make it “means-tested.” Translation: Take money from people who worked hard and hand the proceeds to people who didn’t.
I put into my spreadsheet a 50% probability of this outcome: Beginning in 2033, your benefit is chopped by 33% of the amount by which it exceeds the average benefit. Results, for the healthy version of Harry and Wanda (with the lifespans two years longer): $1.23 million for early claiming, $1.27 million for a split delay.
Conclusion: The political risks narrow but do not eliminate the advantage of delaying.