Tuesday, June 4, 2013

Claiming Social Security at 62 or 70


A consensus in the financial planning profession is that while the Social Security claiming decision is quite difficult and there can be exceptions, it is often beneficial to delay the receipt of Social Security retirement benefits.

I will provide an exploration of this issue. What follows is not an effort to optimize any decision-making, but rather to observe the long-term impacts of two different types of claiming strategies. I'm considering the case of a 62-year-old male who has left the workforce. This person may or may not be married, and I'm not making any effort to separately determine about a spousal claiming decision.

The 62-year-old leaves the workforce and is estimated to have a $2,500 monthly Social Security benefit at the full retirement age of 66. If this person claims that Social Security benefit at 62, they are entitled to receive 75% of the benefit. On the other hand, if the person waits until age 70, they will be eligible to receive 132% of the benefit.

The 62-year-old has $1 million in assets and a lifetime inflation-adjusted spending goal of $60,000 per year.

The first option I consider is that this person begins Social Security at 62 and then uses financial assets to cover the remainder of their spending needs for as long as possible (as long as assets remain) throughout their retirement.

The second option is that this person delays Social Security until age 70, but purchases an eight year period certain immediate annuity. This is not a lifetime annuity, but an annuity that makes payments for eight years and then stops regardless of whether or not the beneficiary is alive. This immediate annuity is not inflation-adjusted, so it will not provide precisely the same income as Social Security would have given with its inflation adjustments, but I otherwise assume that the individual withdraws what they need from their portfolio to spend $60,000 per year after accounting for any income first from the annuity, and then later from Social Security.

The age 62 Social Security monthly benefit is .75*2500 = $1,875. Currently, according to Cannex, spending $100,000 on an eight-year annuity provides monthly income of $1,084. Thus, with the second strategy, I assume the person spends $172,970 to purchase the annuity that will last through age 70 when Social Security benefits begin.

The following analysis is based on 2000 Monte Carlo simulations, with portfolio administration fees of 0.2%. Market returns and inflation are stochastic, and are based on the same current market conditions I have been using in recent research articles.

For the two strategies, I will track the real spending and real remaining wealth over retirement. The figures show the 10th, 25th, 50th, 75th, and 90th percentiles of outcomes. For spending, the distribution is not wide since I assume that the person spends $60,000 per year (in inflation-adjusted terms) for as long as possible. When the dashed lines fall from the spending level constant, it means that wealth is depleted first at the 10th percentile, and then at the 25th percentile, and so on. When financial assets are depleted the only income that remains is the Social Security benefit (wealth is never depleted in the first eight years when annuity income is part of the budget).

For both strategies, I assume a fixed asset allocation of 40% stocks and 60% bonds for the financial assets.

Strategy 1: Claim Social Security at age 62

real income 

 
real remaining wealth






Strategy 2: 8-Year Annuity + Social Security at 70
real income



real remaining wealth




With Strategy 1, the impact from claiming Social Security at an earlier age is that financial assets are more likely to be depleted and that income drops further in the event of portfolio depletion. The approach used in Strategy 2 of combining the annuity and delaying Social Security makes retirement spending plan more sustainable over the long-term horizon and reduces the harm caused by financial asset depletion. In other words, running out of financial assets is both less likely to happen and less damaging when it does happen.

The main reasons why this is the case is that the benefit increases built into delaying Social Security assume a real return on underlying assets of about 2.9%, which is quite favorable compared to what investors could expect with their portfolio.

The other interesting impact to observe is the distribution of remaining real wealth over retirement. Immediate uptake of Social Security can potentially allow for a higher bequest if one dies early in retirement, but the potential for leaving a bequest actually improves later in retirement with the delayed Social Security strategy. This has rather interesting implications for anyone seeking to provide a legacy to the next generation. 

We must think about the marginal utility of wealth. if someone dies early in retirement, they will leave a larger nest egg to the next generation, and the fact that Strategy 1 provides an even bigger nest egg than otherwise may not have all that much impact on the lifestyle of the recipient. But in cases with a more lengthy retirement period, the nature of this bequests changes. Delaying Social Security makes it less likely that financial assets are depleted, which means there will be less strain on any potential bequest recipient to provide reverse  support to the retiree, and as well the potential to leave a larger quest actually is higher with delayed Social Security in these cases when the available bequests with both approaches are less and each dollar of bequest will count for more. In this sense, a retiree may actually be doing a favor for the subsequent generation by delaying Social Security, which may be a counterintuitive result.



18 comments:

  1. An excellent description and argument for the benefits of the bridging strategy Wade. It seems too that the small difference between the annuity and just setting aside the money as cash ($180,000 in your example)is not a significant difference for those who can't find, or don't want, an annuity as part of the strategy.

    One of the most succinct explanations there is!

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  2. You explicitly say that you are not considering survivor benefits. But it seems worth mentioning that the way that survivor benefits are calculated makes the case for delaying claiming MUCH more compelling for the higher earner in married couples, although sometimes not for the lower earner.

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    1. Yes, you are right, and thank you for making the point.

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  3. Great article! I wanted to point out a recent blog post about the potential financial benefits for seniors of installing solar. Creates income, avoids utility expenses and hedges against future increases in utility rates. Check it out here http://blog.energysage.com/2013/06/

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  4. Would you consider a third option; suspend SS until 70, but exceed SWR by the age 62 payment that you are entitled to with that 40/60 portfolio (to compensate for the loss of the social security), and then go back to a portfolio-adjusted SWR at 70 with the addition of the age 70 social security payment.

    An annuity-free option that should give those first two some real competition. Rephrased, an option that cuts out middle-men (the annuity provider) who will most definitely make a profit on you, first and foremost, the entire loss of principle on day 1.

    @bradleymyers - twitter

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  5. Wade, Clear, well written, and helpful. Keep up the great work.

    Two thoughts for your consideration:

    1. Using 20 basis points for investment expenses presumes not only an index (as opposed to active portfolio management) approach but also a non-load approach as well. What happens in your model if you assumed 120 basis points instead of 20 basis points for investment expenses? I think it's impossible to understate the importance of utilizing low cost investments not only during the accumulation phase of retirement planning but also the income phase as well.

    2. Conceptually, a fixed period annuity works fine to illustrate the bridge from 62 to 70 as would a laddered CD approach.

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  6. Comparing the curves of remaining wealth, it looks like the crossover point is just about 85-88 years of age. That's also the age when the total Social Security benefit curves (for starting at 62, FRA, and 70) cross, and it's also the age when payout from an SPIA exceeds the premium. While the latter two crossing at the same age makes some sense, it doesn't seem obvious why all of these curves will cross at the same point.

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  7. If your 62 year old's 1 million in assets is entirely or mostly in tax-deferred accounts, taking Social Security immediately is the only viable option, is it not?

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    1. It is a high potentail that income tax rates will increase over the next 20-30 years, primariy due to a combination of national debt and demographics. Using IRA-Style funds earlier and repositioning some of these assets earlier (ROTH Conversions) can reduce the amount of taxable income during the back end of the income stream. If a single person is able to convert all of their IRA style assets prior to 70 1/2, they can essentially control most of their taxable income. If they are able to have 100% ROTH income, they can reduce the taxation on their Social Security to 0, thus increasing their actual income later in life by the reduction of the taxes on their withdrawels and their social security income. This could allow them to maintian the risk profile on their investments yet recieve a better "net return".
      This is even more significant if this is a married couple due to issues upon first death.
      The tipping point for early versus late on Soc Security is @ age 77. Most people underestimate their longevity.

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    2. This comment has been removed by the author.

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  8. Great information. I've been trying to calculate my retirement and found that if I sell my structured settlement I can actually retire 2 years earlier! Has anyone ever given this strategy any thought? Does anyone think it's a good idea?

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  9. thanks Wade
    I especially appreciated you putting this issue in the "big picture" of marginal utility of wealth regarding bequest issues. Delaying social security as a hedge against leaving a "reverse support" bequest is something I had never thought about before. Very helpful.

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  10. IMHO-I think the gentlemen is farther ahead taking social security at 62. First there are eight years of freedom and enjoyment taking social security at 62 and $22,500 he doesn't have to take from his nestegg. And one million would have to have a return of only 3.75% to have the 60,000 the retiree wanted. In 2012 if he was married and had his assets split between tax free and taxable accounts and took $20,750 from taxable or tax deferred accounts and $16,750 from a Roth or regular savings his total Federal income tax bill would be $125 after using the Social Security worksheet and standard deductions. If he was single he would take $13,750 from taxable accounts and $23,750 from tax free Roth or savings and his tax bill would be $400. Most pre retirees do not realize the reduction in federal taxes if they have planned their buckets of money properly. Even if this gentlemen went in to 3% long term CDs, 3.5% bonds or 30 year treasuries recently yeilding 3.18% he would be down less then $100,000 at age 70 and at 3% the $900,000 plus would give $30,000 plus in income and then dividing that $900,000 into 10, 20, or 30 years gives an additional possible income of $90,000, $45,000, $30,000. I don't think giving $172,970 to an insurance company to get $1875 per month is smart or efficient use of funds. His $172,970 divided by 8 equals $21,612.25 annually or $1801.77 monthly without any growth. So the total given back to the gentlemen over the eight years besides his own $172,970 is $7,030 ($878.75/per year or 0.508%! A 3% CD in one year would give him $5189 and making up the difference for the eight years would amount to $72,854. The insurance company pockets over $100,000 and whatever else they have made on the money and there's $172,970 less for a legacy immediately from age 62.

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