Claiming Social Security benefits is a complicated issue,
particularly if you are married or divorced. In many cases, it’s an emotional
one, so I will need a few posts to even cover the basics.
But this I can tell you up front: Social Security is the
most reliable source of retirement income most Americans will have and when you decide to receive benefits is,
unless you are quite wealthy, the most important retirement funding decision that
you will make.
There are three primary ways to pay for retirement: 1) pensions,
2) personal retirement savings in 401(k)
and other savings accounts, and 3) Social Security retirement benefits. Many
studies include home equity by assuming that retirees will take out reverse
mortgages to generate income, but I find that troublesome. First, most people simply
don’t take out reverse mortgages for various reasons and second, studies show
that about 85% of Americans want to retire in their current homes. Many want to
pass their home to their children.
Nonetheless, a Boston
College Center for Retirement study found that taking out a reverse
mortgage would add about 10% to the number of Americans who have saved enough
for retirement. In other words, for many households, successfully funding
retirement will require tapping home equity with a reverse mortgage or by
downsizing.
Pensions work fairly well, but they have all but disappeared
since the early 1980’s. Mostly public workers like teachers, firemen and the
military have them now.
Pensions were largely replaced by 401(k) accounts beginning in the early 1980’s, transferring the risk of
retirement financing from businesses to individuals. As I pointed out in an
earlier post, the personal savings approach (401(k)’s, IRA’s, etc.) has only worked for a very small percentage of
American households. That leaves Social Security benefits to serve as the
backbone for retirement financing.
Regardless of how you feel about Social Security as a social
safety net, it is unquestionably the most secure component of retirement
income. Without Social Security retirement benefits, most of our elderly would
live in near poverty. About 14% of all Social Security recipients derive more
than 90% of their income from those benefits. For about half or recipients, it
contributes 50% or more of their income.
If you qualify for these benefits because you paid FICA
taxes for 40 quarters or more, or because you are married to someone who did,
deciding when to claim them may well be the most important retirement financial
decision you make. That’s because the amount of your benefit will depend on
when you choose to receive it.
You can receive these benefits as early as age 62, but every
year you postpone receiving them, they will increase about 8% in value. They
stop increasing after age 70, so there is no gain from postponing them past age
70.
For example, you might receive a benefit of $1,000 a month
for the rest of your life if you claim benefits at age 62. If you forego those
payments for twelve months, though, you might receive $1,080 a month for the
rest of your life.
On the other hand, it may turn out that you have no decision
to make.
Nearly half of retirees recently surveyed (45%) say they
were forced to retire earlier than they had planned, typically because of
layoffs, health problems, or the need to take care of a spouse. You may plan to
retire later than age 62, but life won’t necessarily oblige.
If you can postpone claiming, however, it will be the most
effective way possible to improve your retirement income. It helps in three
separate ways. First, it increases your benefit, as I explained above, by about
8% each year that you postpone claiming. Second, it delays the date when you will
need to draw down your personal retirement savings to pay living expenses, so
your savings will last longer. And third, it gives you a few more years of work
income to contribute to your retirement savings.
Assuming you’re in the 55% of workers who actually get to
make this choice, why wouldn’t you choose to wait?
First, you might need the income at age 62, in which case
claiming early is a no-brainer.
Second, you might be persuaded by the “break-even” argument
that says you have to live 10 years or so before you are paid back for the
years you elected not to receive benefits. This is a specious argument and one that
I will explore in my next post.
Third, you might believe that the entire Social Security program
will go away before you can take advantage of it, so you should grab what you
can get while the grabbing is good.
I don’t buy the latter argument for two reasons. First,
conservatives have been trying to eliminate the program since its inception in
the 1930’s without success. People love Social Security and it has proven
politically disastrous to recommend ending the program. Second, eliminating
Social Security would create a massive elderly poverty problem, and so would be
self-defeating as a way to cut the federal budget. Americans aren’t going to
let their elderly starve.
Still, if you feel strongly that the program will go away,
claiming early would be a rational choice, though I don’t recommend it. The
reality is that only very wealthy people can afford retirement without Social
Security.
So, here’s my first bit of retirement advice for people who
won’t accumulate several hundred thousand dollars in retirement savings by
their early sixties.
Postpone claiming Social Security retirement benefits as long as you
can up to age 70.
This is especially true if you are the higher earner of a
married couple. If you are the lower earner, it may make sense to claim as
early as your full retirement age (66 for people retiring soon), and have the
higher earner postpone his benefits as long as possible, but that is a more
complicated decision that I’ll address subsequently.
Social Security retirement benefits are a deferred joint lifetime
annuity. Those benefits are paid to you and your spouse for as long as you
live. You could purchase an annuity that is equivalent to your Social Security
benefits from several insurance companies, though it would be expensive.
Social Security retirement benefits are a single premium
immediate annuity with inflation protection. You could buy one of those from an
insurer recently with a 3.875% payout, meaning it would pay $38.75 per year for
every $1,000 of annuity you purchased.
The average household Social Security benefit in 2012 is
about $14,000 a year. Divide that by .03875 and you get $361,290. That’s the
amount you would have had to save to purchase an annuity equivalent to the
average Social Security benefit in 2012.
You can divide your own annual Social Security benefit by
.03875 to see what your benefit is worth. In fact, I suggest that you head over
to the Social Security website and use their calculator to estimate
your benefits and calculate how much you would have had to save to buy those
benefits. (Remember to multiply the monthly benefit by 12 and then divide by
.03875.)
I recommend that you consider your benefits as longevity
insurance, guaranteeing that you will have substantial income if you live a
very long time. If you do so, the value of postponing claiming benefits will be
obvious.
The best argument for delaying benefit claims as long as
possible is the sentiments expressed by many elderly women who have outlived
their spouses by two decades and now suffer with a benefits check that could
have been as much as 85% larger. Their biggest financial regret is that they
and their spouses claimed Social Security benefits at too early an age.
In my next post, I’ll explain why break-even analysis is a
poor way to decide when you should receive your benefits.
No comments:
Post a Comment