Though I won’t be posting this until
arriving at the hotel in Palo Alto, I am writing from somewhere over the
Pacific Ocean, as I fly from Tokyo to San Francisco to attend the Stanford
University Center on Longevity’s “Retirement Planning in the Age of Longevity” conference. I’m looking forward to that,
and I’m planning to “borrow” Bob Seawright’s format (he is providing excellent real time notes from the CFA Institute annual conference in Chicago) and
provide real time summaries of the discussions at the conference. I realize, as
perhaps Bob figured out, it makes a lot more sense to provide stream of thought
notes, as otherwise I might never get around to write up complete essays about
the event.
Though I am not a big fan of these
cross-ocean flights, I do find they provide a good opportunity to get some work
done. That is easier to do with an empty seat next to me. I’ve developed a
theory for how to accomplish this, and it paid dividends on this flight. Just
choose an aisle seat in the center part of the plane near the back. For
whatever reason, plane seats tend to be assigned from front to back, and so in
the case that there are empty seats on the plane, they tend to be found in the
back center parts of planes.
On the flight I’ve been reading William
Reichenstein and William Meyer’s Social Security Strategies: How to Optimize Retirement Benefits.
My dissertation was about Social Security
reform. As such, I’ve read more of the Social
Security Administration Handbook than any human being should be forced to read
(just as an aside, how did the Social Security rules ever become so complicated
in the first place? It is not like the tax code where special interest groups
are always pushing for exemptions. It seems like Social Security rules could be
vastly simplified by sticking with a few principles, such as people with
similar situations should be treated similarly no matter if they are married or
single. The problem is, these rules were developed a long time ago when it was
still the norm that only one spouse works… Social Security isn’t really
designed to deal with the complications of having both spouses work). I’ve
written programs to calculate AIMEs, PIAs, adjustments for the age of initial
receipt, family maximum benefits, child benefits, survivor benefits, and so on.
But time flies, and I wrote those programs about 10 years ago and felt I’ve
become rather rusty on these matters in the intervening years.
So I am glad that I did at least understand
the basic idea of the book. I found I was confused about one particular rule,
as when I was trying to explain to some relatives that it probably isn’t a good
idea for both spouses, each with a full career, to begin their own benefits at
age 62, I was wrong when I told them that, fine let the husband begin his
benefit at 62, but the wife (who I think may have a long life span) should just
take the spousal benefit from her husband’s record from 62 until 70, and then
begin her own benefit. It turns out that I am wrong about this… this strategy
can only be done when the female spouse reaches her full retirement age
(somewhere around 66 now), as prior to that you cannot apply for a spousal
benefit without also applying for your own work-history benefit. If this makes
no sense to you, then you are in for a real treat when reading Chapter 4.
And so, the objective of the book is how to
strategize to get the most out of your Social Security benefits. The book is
relatively straightforward through the end of Chapter 3. It covers the basics
of Social Security and also how a single individual can maximize Social
Security. The book does get vastly more complicated in Chapter 4, which is
about couples. The problem is, for couples in which both spouses work, each
spouse is potentially eligible for benefits based on their own work record
(plus your spouse is also eligible for a benefit based on your record), plus a
spousal benefit based on their living spouse’s work record, plus a survivor
benefit based on a deceased spouse’s record. Divorcees can get something too,
with different rules, if the marriage lasted at least 10 years, but those with
multiple ex’s or young kids should watch out for that family maximum benefit
based on one earner’s record)
I’m not going to try to explain Chapter 4
in detail, but this matter is important to me as the curriculum director for
the Retirement Management
AnalystSM designation. Especially for lower and middle income
Americans, Social Security may end up providing the vast majority of retirement
income. And so it is very important to get Social Security claiming decisions
correct. To be clear, Social Security claiming decisions are defined as: “a decision
as to when a single individual will begin their own benefit or when each
partner of a couple will begin their own benefits and, when applicable, their
spousal benefits.”
As the authors show, a wrong decision on
Social Security could end up costing retirees a couple hundred-thousand dollars
worth of lost benefits. But as I think the authors also clearly show, becoming
a factotum on Social Security matters is really complicated. I think it is
asking too much for advisors to become deeply knowledgeable about these Social
Security rules. But at least I think they should have a solid understanding of
the basic principles and be able to figure out approximately correct solutions,
and also have a working knowledge about how to use software that will allow
them to show retirees the outcomes from different claiming strategies, and to
narrow in on a good claiming strategy for both spouses. I should note that the
authors of the book do offer software as a part of the website, www.SocialSecuritySolutions.com,
but I haven’t had an opportunity yet to test it for myself.
What are the basic principles?
First of all, there is no universal answer
for anyone. That is because retirees can make their decisions using two
different criteria, and there is a tradeoff between which strategy performs
best for the different criteria. The first criterion is:
1.
Retirees should pick the
Social Security strategy which maximizes the net present value of their
lifetime income from Social Security. And given the fact that current real
interest rates are quite close to zero, this is more or less the same as
choosing the strategy that maximizes the total lifetime amount (in real terms)
of benefits received from Social Security
And the second criterion is:.
2.
Retirees should take
advantage of the fact that Social Security provides an inflation-adjusted
annuity which increases its payments when delaying the claiming decision through
age 70. This helps protect against longevity risk, and it can help extend the
life of one’s financial assets as well. The idea being, even if you retiree at
62, you can delay starting Social Security until age 70, such that you spend
down more of your financial portfolio between ages 62 and 70, and then spend
from your portfolio at a lower rate after that. They show the benefit of delay using
deterministic assumptions for asset returns and it is not a sure bet (a
particularly bad sequence of returns around age 62 could possibly leave you
better off with starting Social Security earlier) but their point is fairly
persuasive. More risk averse retirees
should delay claiming Social Security until later, because the longer they live,
the more they will end up benefiting from the annuity properties of Social
Security benefits.
Retirees must think about their life
expectancy, and how important it is to protect one’s income level in the event
of living longer than expected. In thinking about these two criteria,
Reichenstein and Meyer develop several lessons to help summarize the Social
Security rules.
Lesson
1: For a single individual living to age 80,
it does not really matter what age to begin Social Security, 62 to 70. The
total lifetime benefits received will be about the same, since Social Security
is meant to be “actuarially fair” with benefit reductions and increases
calibrated to life expectancies. But for retirees living “well beyond” (this
term is defined and discussed in the text) 80, it becomes increasingly
attractive to wait until 70. This is how Social Security provides protection
against the risk of outliving one’s assets.
Then, for the vastly more complicated case
of couples, we get two more general lessons:
Lesson
2: For the higher earning spouse, the relevant
life expectancy for the claiming decision is the life expectancy of the second
spouse to die (which is higher than either spouse alone). The relevant life
expectancy for the lower earning spouse is that for the first spouse to die.
And:
Lesson
3: If at least one of the spouses lives “well
beyond” the age when the higher earning spouse turns 80, then the couple can
usually maximize their joint lifetime benefits by having the higher earning
spouse wait until 70 to claim his/her own benefits.
As a penultimate observation, as the
authors note, for people aged at least 55, it is not a good argument to start
benefits as soon as possible because you want to get what you can before Social
Security “goes bankrupt.” Even if the Trust Fund empties, Social Security is
not finished. It is just that benefits would have to be reduced equally for
everyone to match incoming contributions to the system. Your benefit would be
reduced equally no matter when you started, and there is no chance to gain from
starting earlier for this reason.
Finally, is the book worth reading? I didn’t
even get to the issues of benefits taxation and the earnings test in Chapter 5,
and it does seem like you should want to do your homework to develop a good
Social Security claiming strategy. While the book is complex, it is probably
worth working through carefully to figure out what will be best for your own
case. I can’t summarize it all, but the authors describe a variety of scenarios
based on factors such as: the ratio of PIAs between the low-earning and high
earning spouse, the relative ages of the two spouses, and the projected life
expectancy for each spouse. Decisions also relate to the relative importance a
retiree places on maximizing lifetime benefits (when death is expected before
around 80) vs. obtaining longevity protection for a lengthy lifetime. As
suggested, these efforts could have major implications for making sure you don’t
unnecessarily leave oodles of money on the table. The authors describe these
matters in probably about as clear of manner as can possibly be expected given
the complexity of these issues.
Related Reading: Michael Kitces' "The Asymmetric Value of Delaying Social Security Benefits As The Ultimate Hedge"
There is a relatively straightforward discussion of how a couple optimizes claiming in most circumstances available at http://crr.bc.edu/briefs/why-do-women-claim-social-security-benefits-so-early/
ReplyDeleteThanks, that is a good point. I should try to put together a collection of some of the good work the CRR has been doing to explain Social Security basics.
DeleteWade --
ReplyDeleteDo you agree with their "first criterion"?
Seems to me that in all your work on withdrawal rates, and also on investment choices during retirement, your emphasis is heavily on being OK in worst cases, and that's the right approach, and it oughta be the main consideration in SS strategy too.
Do you agree?
Dick Purcell
Dick,
DeleteGood question. I suppose the answer may partly depend on the amount of other resources you have available to help you hold off starting Social Security.
They are not saying criteria 1 is superior, but just that this is usually what people think of first.
The issue here is that you are leaving money on the table and have less income for a long life, which isn't exactly the same as the "failure" that must be avoided. So I can understand that people may want to lean toward this.
I think the case is pretty strong about seeking the longevity protection benefits of Social Security, but I suppose I do not have any strong opposition to the criteria 1.
What do you think?
Wade –
DeleteI sure agree with your first sentence, but it seems to me that situation pre-empts the question. If you NEED the SS money before age 70, then PV versus longevity doesn’t even get considered – just start getting the money you need now.
At the other extreme, there are a few of us rolling in so much money no SS is ever needed, it’s just a little extra. For those few, the PV approach makes sense. (I don’t even know what/if the super-rich get SS, from which admission a discerning reader will deduce that I am not there yet.)
But for everyone else, who can get along without SS until 70 and is not just rolling in wealth, I think it is no contest. The PV approach is wrong-track thinking, longevity/worst-case is the basis for the decision.
I just glanced at the Michael Kitces post on this topic that you linked us to at the bottom of your post. Based on just glancing and reading his ending questions, I suspect he agrees.
Dick Purcell
Dick,
DeleteYou are probably right.
Now the next question is, why do so many people start Social Security as soon as they can at 62?
Thanks.
Wade, Dick
DeleteThe same deferral structure exists in Canada. If you compare the value obtained via deferral with the cost of a commercial annuity providing the same incremental benefit you will typically find that government benefits are a good deal relative to commercial annuities. To some extent this is related to difference in mortaility expectations resulting from adverse selection.
On the concept of family maximums, thankfully for all involved, amounts paid to ex-spouses based on disability or age are not included in the calculation. :)
ReplyDeleteRegarding actuarial fairness, I think that's only very-roughly-sometimes-applicable. For example, for a single person with an average (i.e., half male, half female) life expectancy, delaying Social Security should be actuarially neutral -- if the legislatively-baked-in discount rate is appropriate given current market interest rates.
No simple adjustment can be exactly appropriate given that both life expectancies and interest rates both change frequently. But the adjustment still seems to be very close to actuarily correct; see http://crr.bc.edu/briefs/can-the-actuarial-reduction-for-social-security-early-retirement-still-be-right/
ReplyDeleteThanks all.
ReplyDeleteOne point that came up at the conference today was that the actuarial fairness calculations have a built in implicit real interest rate of 2.9%. Since real rates are so much lower than this now, it is another reason that makes deferral more attractive at the present time.
Wonderful, just what a blog it is! This blog has provided the helpful data to us continue the good work.
ReplyDeletehttp://www.best-5-home-security-companies.com/vivint-security/