The Value of Waiting – Social Security
In considering claiming strategies for Social Security, one can consider many factors, including other resources, age, age of spouse, level of benefit, spouses own benefits, health, estate desires, tax effects, effects on Medicare Premiums, etc. One of the most common processes is to try to predict one's life span in order to maximize the total benefit over that interval. This method boils down to the following general rule: If you live long, it pays to wait; if you live short, it pays to not wait. Problem is, we don't know, for the most part, whether we will live long or short. Also, other considerations may outweigh simple maximization.
Another significant factor that bears consideration is that Social Security, by being a government-guaranteed life annuity with a cost-of-living adjustment, provides some protection against the risk of outliving your money, that is, longevity insurance. The way to maximize this protection is to wait to make the claim.
The amount of the Social Security retirement benefit increases meaningfully as the start date is delayed from the earliest claim date of age 62, through Full Retirement Age (FRA) 66, and on to age 70 which is the maximum deferral age. The discount (cutback in benefit) for claiming early (before FRA) is substantial, amounting to about 6 2/3 percent per year. So, making the claim at age 62 yields a benefit of about 75% of the full benefit. That reduction is in addition to the Earnings test that applies the period before the claimant reaches full retirement age. The earnings test causes a claw- back of SS benefit on any amount earned over the earnings test level, now $17,040. After FRA, the earnings test is eliminated. Further, after FRA, the benefit for deferral goes from 6 2/3% per year to 8% per year, so that at age 70, the benefit amount will be 132% of the FRA amount.
Interestingly enough the percentage difference in benefit is roughly the same between age 62 and 66 as it is between 66 and 70. Further, the increment each year between 62 and 70 is similar but not identical, ranging from about 6.5% to 8.3%. See Percent Change in the Table below.
The increase in benefit between ages 62 and 66 is about 33%. Similarly, the increase in benefit between ages 66 and 70 is about 32%. The total increase between ages 62 and 70 is 76%. That is, the benefit started at age 70 is 76% greater than it would be at age 62 for the same earnings record / Primary Insurance Amount (PIA). (See the table below)
The increase in monthly benefit is not free. It is paid for by the “cost” of the benefits foregone. This means that there is an investment, and a return on the investment or cash on cash payout. The notion of investment return is made somewhat meaningless since the life of the return is unknown when the investment is made. However, a breakeven period using cash on cash is easy to calculate and gives a reasonable indication of the payback/payout.
The table below shows payout terms assuming an annual Cost of Living (COLA) averaging 1.5%. Historically the COLA has been closer to 2% but in recent years we’ve seen zeros. With that COLA, the payout terms run between 10 and 12.5 years. As the years aggregate, as will happen in reality, the payout term converges around 11 years from the end of the deferral period. So, if you wait until age 70 to start your benefit, your payout period will run into your early 80’s. A bigger average COLA shortens the payout term.
So, waiting to claim your benefit has the effect of increasing your monthly benefit. If you expect to live long and could be at risk for running short on money due to longevity, having the bigger benefit could be reassuring. If the alternative takes place and you live short, you most likely will not have run out of money since your retirement period will have been shorter and you will have been less likely to have needed the benefit. Further, if you are married and your spouse survives you, the benefit available to your spouse in later years may be greater under the "waiting to claim" alternative.
Applying a discount rate (present value) to the calculation extends the payout term and diminishes the value of waiting. The higher the discount rate, the longer the payout term with some terms reaching well into the retiree’s 90’s. It is possible to rationalize either calculation method (with or without PV), and either (or both) may be reasonable.
This analysis does not consider the effects of taxes and other consequences such as Medicare premiums. An early claim can moderate the tax impact over time, while waiting to claim can create a low-income period prior to age 70 that can be beneficial for other tax planning strategies. Higher income from waiting can raise the level of Medicare premiums that will be paid by the retiree. These effects can outweigh most other considerations.
So, while we generally like the idea of waiting to make the Social Security claim, there can be many reasons not to do so. It is not an exaggeration to say that each person’s situation is unique.
We are here to help you think through this.
Social Security – Payout Terms for Waiting to Claim
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The table below shows the returns through June 30, 2018 for selected investment asset classes. In most cases, the results below are appropriate benchmarks for the related mutual funds in your investment portfolio.