Friday, December 19, 2014

Game Theory and Social Security Benefits

In A Tiny Bit of Game Theory, I explained a few basics of this study of decision theory. The Social Security claiming decision provides a good example of how to analyze a financial decision with game theory.

Our Social Security game will be a stochastic game against nature in which nature decides your life expectancy, which is, when you think about it, pretty realistic. Unrealistically, we are going to assume that you will live to age 64, to age 70, or to age 95 to simplify the game.

Your choices as the player are to claim benefits at age 62, full retirement age of 66, or at the maximum age of 70. We will assume that you are a single retiree with a typical lifetime record of FICA payments. Having a spouse makes this a very different game, of course, and a lot more complex. So would adding all the claiming age options.

For payoffs, I’ll use the total estimated lifetime benefits for each claiming option according to the Social Security website at SSA.gov for a single person born in 1955 and currently earning \$75,000 annually. In this first game example, we will further assume that the retiree has adequate retirement savings to support her lifestyle between retirement at age 62 and the age at which she will claim benefits.

This simplified game in matrix form with lifetime Social Security benefits payoffs in 2014 dollars will look like this:

The retiree will need to also make a decision about her overall objectives. Many game theory analyses select strategies that will avoid the worst-case loss. Prisoner’s Dilemma, for example, encourages each perpetrator to confess first and avoid the longest prison sentence. Mutually-Assured Destruction was also an attempt to minimize the worst-case scenario, a nuclear war. These are referred to as “maximin” strategies because they seek to maximize the minimum outcomes. In other words, they seek the strategy that has the best payoff from among worst-case scenarios.

Some retirees want to minimize the chances of “leaving benefits money on the table.” They decide to claim as early as possible in case they don’t live long enough to “break even”. This strategy seems wrong to me on so many levels, but to each his own. Game theory allows us to analyze the problem with a wide range of potential objectives.

The table below shows how much Social Security benefits a retiree might “leave on the table” by waiting to claim but dying before the break-even age, which in this example ranges from ages 75 to 78 depending on the claiming ages.

As you can see from the payoffs, if you won’t live very long, you will maximize your total lifetime benefits by claiming as early as possible (Table 1) and if your objective is to wring every available dollar out of the U.S. Treasury (Table 2), claiming early would be the way to go. Of course, if you’re wrong about your checkout date, you might have done significantly better by claiming at a later age.

If you live to be very old, then you will receive the greatest lifetime benefit by claiming at age 70, when benefits top out. If you plan to live a long time but don’t, you will have missed years of benefits by not claiming early.

For retirees with the “maximin” objective of protecting against the worst-case scenario, claiming at 70 is the best choice, because minimizing your benefits by claiming them at age 62 and then living well into your 90's will be very painful for a very long time. The formal name for Social Security retirement benefits is Old Age and Survivors Insurance (OASI) and claiming as late as possible is the best use of benefits if you view them as insurance. Delaying the claim date for your benefits is the cheapest way to purchase longevity insurance.

I mentioned earlier that for this example game we would assume that the retiree has adequate resources to retire at age 62 and pay for her standard of living until she claims benefits. Another way to implement this strategy is to work longer, if you have the option.

Retirees who don’t have the option to work longer and don’t have substantial retirement savings can’t play this game. They will need to claim early because they will need the income immediately. So, you have more options with Social Security if you also have a lot of money.

I’m sure you’re shocked.

There is one other game theory concept we can introduce with this example, that of dominant strategies.

If you were offered two bets and the first bet always paid at least as much as the second bet and sometimes more, you would always choose the first bet, right? Game theory refers to the first bet as a dominant strategy and the second as a dominated strategy. Game theory tells us never to play a dominated strategy. (And, it tells us that there usually isn’t a dominant one.)

In the Social Security benefits game I have described, there is no dominant strategy that always provides the best results under all circumstances. Sometimes claiming at age 62 pays more lifetime benefits and sometimes claiming at age 70 does, depending on how long you live.

However, claiming at age 62 is a dominant strategy if the objective is merely to leave the minimum amount of benefits on the table and claiming at age 70 is a dominant strategy if the objective is to minimize longevity risk.

Note that I’m not trying to use game theory to explain the best Social Security benefits-claiming strategy. That will depend on your individual resources and goals. I’m suggesting that it provides a good framework for laying out all the options and outcomes and for clearly identifying our objectives so we don’t focus only on the most likely outcomes.

Hopefully, that supports a better decision.

1. What if you prefer to take SS earlier, not to game the system, but simply to reduce the burn rate on your liquid assets? To me, liquidity is a beautiful thing, and a higher burn rate may have an opportunity cost. A lower burn rate might also help with the sequence of returns problem.

1. That is a trade-off that you might personally be willing to make if you value upside "opportunity" more than safety. There isn't one set of values that is the same for every retiree.

However, Social Security benefits increase about 8% (not compounded) for every year you postpone claiming and that's a lot of annual income. That much additional demand on your withdrawal rate is going to increase sequence risk. If you want to minimize the probability of outliving your savings, you're more likely to achieve that by spending your liquid assets first to postpone claiming.

Of course, you need to keep some liquid assets on hand, so at some point you will need to stop spending them and claim benefits.

Liquidity is wonderful, and upside opportunity is wonderful. and not outliving your savings is wonderful. Unfortunately, unless you have a lot of savings, you can't have all three.

2. Dirk-- I think the bit about the increase in SS for every year delayed is frequently taken out of context. Say you are are 66 and have a life expectancy of 20 years. So delaying starting SS benefits by one more year will give you 8% more in annual payouts (before inflation adjustments) but you will have about 5% fewer years left to live (and receive those payouts). So, roughly speaking, the net benefit of delaying SS by one year in this example is 3% per year. Similar math applies to retirement savings; if drawing upon them is delayed by one year (e.g., from age 66 to 67), you could take out about 8% more in each remaining year over one's life expectancy if the underlying investment returns just 3% annually.

3. Yours is a legitimate way to look at the decision if it fits your needs, but it isn't the way I view it. My perspective is that Social Security retirement benefits, or Old Age and Survivors Insurance, is longevity insurance. From that perspective, life expectancy isn't part of the equation. The question is what happens if you liive well past your life expectancy.

Half of retirees will live longer than their life expectancy, and I am unwilling to bet that my wife and I won't be in that group. When I look at Social Security benefits, I want them to protect me if I live to 95 or older or, more likely, that my wife does. I'm not willing to assume that neither of us will live past 88, for example.

But it's your choice and a good decision depends on your own personal circumstances. It's all about how much risk – and which risks – you're willing to take.

Thanks for writing!

2. "That is a trade-off that you might personally be willing to make if you value upside "opportunity" more than safety."

That's not how I'm thinking of the problem at all. Having cash on hand increases my safety. Cash is optionality-- if I have it, and I am looking at a multi-year bear market (just for instance), I can take SS now, perhaps buy an annuity or some other income-generating asset, and ride through the bear market more comfortably. In fact the cash always gives me some defense against some number of unforeseen disaster scenarios. So I have more "opportunities" to avoid total failure of my plan-- it's not just about the upside.

That's what I mean by opportunity-- the "bird in the hand" quality of taking SS now rather than later is a kind of insurance against unknown unknowns. To me, preserving capital should always be preferred by any rational investor. My math-savvy husband says this is a utility function.

I can think of only two situations when I would be willing to burn through my cash-- one, where I can comfortably live on the amount of SS I expect to get at age 70, and two, if I have so much money in cash that I can afford a higher burn rate, and still have plenty of cash left over. What I'm suggesting, is that for a large slice of the population that is "somewhere in the middle," where there is some cash but they are not rich, the :decision" problem of when to take SS is a lot more complex than the simple matrix might suggest.

3. Dirk,
For married retirees, one critical factor in considering when to start claiming SS for the higher wager earner is not one's own life expectancy, but the life expectancy of the other spouse. Survivor planning is very important, especially if there are no pensions which will continue after the first spouse's death or if the SS benefits on the surviving spouse's SS earnings record are much less than the higher wage earner. Even if the high wage earner gets a bad medical diagnosis in his or her 60's, and isn't expected to live until 70, it still might be better to delay collecting their own SS so that they maximize their spouse's SS Survivor benefit. So for many (not all) married couples: "If I am the high wager earner, my life expectancy isn't important, it's my spouse's life expectancy that should determine my SS claiming strategy". This will certainly complicate the gaming strategy.

1. Agree. This is a huge consideration for married couples.

The intent of my post was to suggest game theory as a framework for analyzing the Social Security claiming decision, but I suppose it was inevitable that it would spread into a discussion of various strategies.

I will claim at 70 primarily because of the spousal benefits you mention, but this is a complicated decision with no deterministic solution.

Products like Maximize My Social Security can be quite helpful, but you still have to bet on life expectancy, or postpone claiming and avoid the worst-case scenario, instead.

Excellent point. Thanks for writing!

2. This is very useful post. I have started discussing some the basic claiming strategies with my spouse and with an in-law who is divorced.

The discussion has had to start with getting across the basic concept of SS as a longevity insurance program, like a pre-paid annuity that has various claiming strategies that can get pretty complex for two-income couples.

The game theory discussion may be a good way to get to the second level of the discussion regarding the desired goals and claiming strategies to achieve them. The official Social Security information has generally made their eyes glaze over as it takes a fairly complex topic and works hard to make it impenetrable.

3. It is often a very complicated decision process. In your case, you might try getting agreement on what your goals are (an advantage of the game theory analysis) and then using something like Maximize My Social Security to run the various scenarios. That way you won't have to familiarize yourself with the complex tradeoffs. It knows the rules. If you Google it on the web, there are some free resources as well, but I've enjoyed using this one.

Great comment. Thanks for writing!

4. "If I am the high wager earner, my life expectancy isn't important, it's my spouse's life expectancy that should determine my SS claiming strategy". Exactly; that's how we approach our decision on the UK equivalent - I'm deferring my State Retirement Pension to look after my widow, who is from a very long-lived family.

5. Me, too. Apparently, it's my English heritage.

4. Utility functions are individual and simply express mathematically your personal preference for particular outcomes. The claiming decision is merely a trade-off of liquidity versus longevity insurance. If you choose liquidity, you won't regret your decision unless you live a very long life, but it's your personal choice.

I agree that you should always have some liquid assets on hand. I don't agree that it will reduce your sequence risk. In fact, it's very likely to increase sequence risk because you will be giving up future guaranteed income from Social Security benefits. If you hold this money in cash, you will also increase sequence risk by lowering your portfolio return.

Moshe Milevsky wrote a paper a few years back showing that you cannot depend on a large cash holding to avoid a sequence of bad returns (a bear market). It works a little more than half the time. Advocates of bucket strategies are backing away from large cash holdings because of the reduced return.

There are many rational investors who would not prefer preserving capital to growing their capital. The more wealth you have, the more growth you can pursue and that is completely rational.

And, yes, the problem is much more complex than this simple matrix might suggest. That's what I meant when I said that the example for single retirees is "unrealistic" in its simplicity and that spousal scenarios are even more complicated. The goal was to explain the analysis strategy.

The claiming decision boils down to this: if you live a very long life, you will be significantly better off if you postpone claiming benefits. You have to decide if that's a risk you're willing to take. (This was not the point of my post. I was only trying to provide a framework for the analysis. But since you brought it up, I recommend everyone postpone claiming as long as they can.)

5. Maybe I'm missing something, but I'd say under some circumstances taking SS early almost has to reduce your risk. Let's say I need 50k a year, and my early SS benefit is 25k. If I take that 25k now, instead of spending down all 50k per year until I am 70, then I preserve more liquid capital and/or reduce the amount I need to withdraw from my 401k and/or Roths. If in doing so, I can get my withdrawal rate down to 2% or 2.5%, then I have seriously reduced the risk of failure of my plan. (At that point I'm not too concerned if the return on my cash is pretty low. I'm not trying to get rich, I'm just trying to avoid poverty.)

On the other had, if I wait to 70, I end up with more money every month, but probably not enough to make 50k. That's the hard part! Let's say I still have to make up a 20k shortfall, but now I have spent down my cash. Maybe I now have only a small emergency fund left. And perhaps in the meantime the market has taken a massive dive, so now I have a choice between a higher withdrawal rate, or taking out less money and possibly not meeting my needs. In that situation, I might be tempted to increase my stock allocation, and so my risk could go up.

In any case, I can't take much more money from cash-- that option is gone with the wind.

I just don't understand why I should refuse what amounts to a government guaranteed inflation protected annuity, which is not subject to stock market risk, versus waiting for that annuity and being forced to either spend down my capital, or spend from my investments, and hope the market doesn't have a crash.

The only way I would take that bet is if I were absolutely certain the SS payment at age 70 covered all my needs, so I could transition safely between spending my cash and getting the government check.

When I frame the problem that way, the issue of gaming the SS system by trying to predict how long I will live is irrelevant. Maximizing dollars at some future date is nice, but if you know you are going to have a substantial shortfall anyway, which you must pay out of pocket, why not minimize that sum as much as you can, right from the beginning of retirement? Isn't that reducing risk, at least in the "real world" game?

6. I think maybe what you're missing is that this post makes no across-the-board benefit-claiming recommendation. As it states, there is no dominant strategy.

If you know you are going to have a shortfall, then you probably should not wait to claim your benefits.

Delaying your claim makes sense only if you don't need the income from Social Security right away. If you can work longer or build a TIPS bond ladder to bridge the gap to benefits, you can get a great deal on more longevity insurance.

Most retirees won't have enough savings to wait until 70 to claim, as I mention in the post. In that case, you would change the objectives of the game from maximizing longevity insurance to maximizing income and analyze a different game, probably with a different outcome.

I'm not sure what you mean by "spending down your capital or spending from your investments", your investments are capital. If you're worried about a market crash, lower your equity allocation.

If you need the income right away, then you're right, you wouldn't postpone your claiming age. If you have lots of savings and want to protect your standard of living if you live a very long time, then you would.

But let me say again, this post isn't recommending any claiming decision across the board; it's providing a framework to help make that decision. You're arguing points that the post doesn't make.

1. I just realized I didn't answer one of your questions, why you might want to delay your benefits. Here are a few reasons:

1) Because if you delay those benefits, you can receive even greater benefits in the future and if you live a long time those lifetime benefits can be much greater (you're buying longevity insurance),

2) Because claiming early can also limit spousal and survivors benefits to other family members,

3) Because there are ways to combine some spouse's benefits to increase the total payments for the household that include delaying claims,

4) Because if you don't postpone benefits until at least full retirement age, you cannot take advantage of the strategies in 3) and switch to a higher benefit if one comes available subsequently, and

5) Because you are building a higher income floor in case your savings run out late in life.

There are probably others that I'm missing here. These aren't reasons that you, personally, should delay claiming. They are only reasons that you might.

7. A great post with great follow on discussion Dirk. When it comes to survivor benefits - also thought of as spousal considerations - here's a couple other more complicating considerations to add to the yin and yang you presented (which tend to fit a bit better for singles rather than couples):

1) spousal benefits should be maximized as much as possible so that the survivor of a couple retains the higher of the two benefits (also known as claim the highest benefit last);

2) in the interim until that highest benefit is received, there are strategies "in the game" where some social security benefits may be received by either party, depending on their relative benefit levels, thus reducing the amount needed as a bridge from the portfolio before full benefits kick in.

3) Receiving a higher amount from social security for a greater number of years (more than up to 4 years: age 66 to 70) translates into less risk of exposure to requiring more income from the portfolio over those years ... when a little bit of the portfolio is used up for up to 4 years waiting for higher benefit to kick in.

4) poor health = claiming early (and for spouses - this means again claiming the higher benefit last) - the mistake often made is claiming on the record of the one in poorest health rather than maximizing the survivor benefit to the other.

There are few generalized rules beyond claim the highest benefit last (couples dominant strategy) and taking a look at how various choices play out in the ultimate decision. When uncertainty rules, one might view the rules of the game as to assume the worse (longer than average longevity - which appears to apply to people who have the resources to make such choices (differences between general population stats of social security longevity tables and annuity tables) when making choices and decisions.

Great discussion Dirk!

8. The elephant in the room is the consideration that the government may not pay SS benefits as it gets strapped for cash. That is why some people take SS starting at 62. If you are drawing SS you are very unlikely to be denied future payments. I personally fear that my SS will be means tested away and am keeping an eye as to when to file. Daniel Amerman did an analysis looking at the inflation effect on delaying SS and concluded that much of the benefits of delaying to 70 go away when that is considered.

1. Wesley, you raise some interesting points.

That elephant has never been in my room, though I appreciate the fact that you feel its presence in yours. Fiscal conservatives have tried unsuccessfully to eliminate Social Security since it was created in the 1930’s. Bush tried to “tweak” it a little and was soundly thrashed for his efforts. I think it remains politically untouchable and that there are fairly painless ways to fix shortfalls. Changes are, of course, not impossible, but they aren’t on my list of top concerns.

But they are on yours, so it is perfectly reasonable that you address them and any other risks that make your retirement feel more secure. It’s what works for you that counts.

I will point out that you are basing your analysis on not one, but two improvable assumptions. First, that benefits will be significantly reduced and second that if they are, that you will lock in benefits by claiming early. Perhaps benefits will be reduced. Perhaps benefits would be grandfathered for those already enrolled. But, perhaps they would be grandfathered for those above a certain age, in which case claiming early would provide no additional benefit. Perhaps they wouldn’t be grandfathered at all. That’s a lot of perhaps.

I think this is an area where a game theory analysis provides the important benefit of forcing us to write down our objectives. It sounds like a primary payoff for your game would be mitigating a possible mitigation of future benefit cutbacks. There are many possible objectives.

I suppose there are high inflation scenarios that could significantly impact your claiming decision, but there are several benefits to delaying claiming in which inflation is not a factor. Today, inflation isn’t very scary. I am unfamiliar with the study you reference, but I am aware that the top minds in retirement planning generally recommend postponing claiming as long as possible. William Bernstein referred to it as the cheapest longevity insurance you can buy. That’s a general recommendation; your mileage may vary.

Thanks for writing.

2. This is the link to the Amerman article
http://www.safehaven.com/article/36152/how-inflation-changes-retirement-benefit-choices
Thanks. Great posts as always.

3. Here's my problem with this analysis, and with the anonymous comment above noting that life expectancy also changes when you delay claiming. The article says, "So for someone who has reached retirement age, and then lives to an average age in retirement, the advantage has shrunk from about \$175,000 to a much less impressive \$55,000." (italics are mine)

I believe the anonymous commenter above is referring to the similar fact that total payouts are about the same no matter what age you claim if you assume the life expectancy for that age. So, if everyone lived to their life expectancy (only half of us do), then delaying claims would not be profitable.

However, when we plan retirement, we have a higher hurdle – we need to plan for living longer than our life expectancy. If you live to 95, delaying claims as long as you can will result in higher lifetime payments and lower the probability of suffering a reduced standard of living in old age.

The article you reference and the commenter above are correct – if you don't live beyond your life expectancy.

1. The cited article at the end states that SS has not been keeping up with inflation. It uses the CPI-W to calculate the COLAs. There are no perfect inflation measures, as inflation is really an individual thing based on what you buy. The CPI-W is designed to try to emulate households. However, there has been a big move afoot that the basket of goods is misleading but generally people haven't been able to come up with something much better and more reliable. Most economists believe that the Shadowstats type of analysis overstates the importance of the changes to inflation calculations by the government.

2. There are very, very few things that have the whole amount fully-adjusted for full inflation according to the CPI. Most pensions aren't and even most annuities that escalate with inflation don't. SS is a pretty good alternative for providing long-term inflation protection for the guaranteed lifetime income. This by itself makes it worthwhile to try to maximize.

3. A lot of people are assuming that social security benefits will be cut. There are some changes that can be made that don't cut benefits that would be a major political third rail. For example, 100% of SS, instead of 85%, could be taxed above certain income limits. That would raise revenue without impacting people who rely only on SS. There are numerous other changes that can be made on both the revenue side, such as increasing the maximum earnings limit subject to payroll tax. Also, the potential impact of immigration on work force demographics is always a wild card.

4. Finally, Dirk's comments about the analysis being for people who die at or before the crossover age is important. SS is really an insurance policy against outliving assets built up during your lifetime of working. If somebody has been saving for retirement, they are probably trying to structure their assets to last 20 years or more, so they would likely leave those unspent assets on the table as well as the unused SS if they die young.

5. Good points. The CPI issue is complicated additionally by the fact that elderly people tend to spend more on certain expenses, like medical, that grow at an even faster rate of inflation. The BLS measures this with CPI-E, but Social Security benefits don't use it.

Thanks for the information.

6. Health care cost growth has slowed greatly so that CPI-E has even grown slower than CPI-U and CPI-W over the past handful of years. I suspect that average health care costs will continue to grow slower than the past simply because they are so high right now with lots of inefficiencies in the system. I have family in Canada and it very clear to me that the US system is highly unequal and inefficient. I suspect that healthcare as a percentage of GDP could drop by a couple of percent over the next couple of decades even though there will be more elderly.

Ironically, I think the US and Canada are going to swap efficiency increases over the next two decades. It is clear that Canada is about 10 to 20 years behind the US on low investment fees for small investors as there haven't been low cost options equivalent to Vanguard and T Rowe Price. However, Vanguard and others are now offering low cost ETFs which were completely unavailable even a couple of years ago.

So I think the US will see healthcare costs declining towards the Canadian costs while Canada will see investment costs declining towards the US model. Late middle age and elderly on both sides of the border should be benefitting form this.

An interesting thought on the CPI - investment costs are not part of it. As my portfolio gets bigger, my fund expense ratios become a bigger and bigger percentage of my total costs. However, since they are netted out from returns they are essentially invisible. But my actual average expense ratio has declined by at least 2/3 since the 1990s, so quietly my portfolio has had that aspect go through a significant deflation.

7. CPI-E did grow slower than CPI-U a few times in the recent past (usually a tiny bit slower), as this chart shows, but whether this is a trend or a blip remains to be seen. This was mostly the result of healthcare costs but, unfortunately, I don't forsee any sea change in the cost of medical care. Medical costs have declined a bit with ACA, but it is going to take more than that to stop this juggernaut.

When I started investing in the eighties, nearly all funds had a load, often near 5% or even more, as I recall, and I would pay \$200 to \$300 in commissions to buy a couple of hundred shares of stock.

In the rare event that I trade an individual stock now, I might pay eight bucks in commissions and I buy index funds with no load and an expense ratio slightly north of nothing.

Here's hoping Canada catches up soon.

9. Yet another complicating consideration -- claim before full retirement age and you lose the option to switch to a higher benefit if one becomes available later.

For most households, this will be an easy decision. They will need income right away and need to claim early. For those with options, the decision can be complex.

I studied the rules and ran through Excel spreadsheets for weeks, then decided to buy the software, just to be sure. For households with claiming options, this is probably an important enough decision to warrant getting professional help.

Thanks, Larry!

10. Nice article.
As a Realtor, my income cratered in 2007, and has not fully recovered. I have worked two part time jobs for the last 6 years, and my wife took on a great job, but a stressful one, for the benefits about that time.

I have read up on SS for the last 30 years and planed all three scenarios you mentioned. However, taking SS at age 62 allowed my wife to quit her job, and me to drop one part time job. (She now has a home based business.) SS provides our monthly safety net. In the 15 months of "semi-retirement", we have not had to touch our retirement savings. SS, plus rental income, plus our part time jobs are covering our budget, plus allowing extras. An extra bonus is the re-adjustment of my early SS benefit due to continued working, and low income college years dropping off the "top 35 earning" years. If I happen to hit a home run selling real estate, and go over the maximum allowed earnings (for early retirement), I will get the money "taken away" as an adjustment at full retirement age (many do not realize that).

My personal thoughts are that taking SS is a very personal choice, and needs much forethought due to circumstances at the time of the first offering. This choice is working very well for us, but it isn't best for everyone.

Keep up the good work, Dirk.

1. Well said, and exactly the point of my post – it depends.

Thanks for bringing up the rule about earnings if you claim early and are employed after you begin receiving Social Security benefits SSA.gov . You're right, people need to know that. Your benefits will be increased at FRA, but reduced if you earn more than the limit before then.

Benefits are quite complicated and the right choices depend on your circumstances and goals. Do you need the income right away? Are you single and want to maximize income? Are you married and want to protect your spouse? Is your goal to provide longevity insurance? These are all factors that would lead to different decisions.

Thanks for writing!

11. Great post. One question, how do taxes fold into the decision? For example, assume RMDs are substantial but a person retires at age 62. The income tax rate on this retiree will be relatively low from years 62 - 70. At that point, the retiree will be in a higher tax bracket.

1. I try not to worry too much about taxes ten years from now because tax rates change. They have changed tremendously over my lifetime (remember the Beatles song Taxman?) Will more of our Social Security benefits be taxed ten years from now? Will Congress change tax rates? I have no clue.

If you're worried about required minimum distributions from your IRA accounts, spending down those IRA's while you postpone Social Security benefits will reduce the balance in those accounts and thereby reduce taxable RMD's later. (Of course, a bad bear market will do that, too.) This is especially important if you're trying to avoid the "tax torpedo." So, people with potential tax problems from RMD's have another reason to postpone Social Security benefits.

Tax issues are highly individual, so you really have to do the math, or have someone do it for you. As I recall, ESPlanner does a fairly nice job of comparing various assumptions regarding both Social Security claiming options and retirement account withdrawals. Beware, however, that many people complain that the software is difficult to understand. Also, be aware that your results will be no more accurate than your ability to predict future tax rates and future portfolio balances.

Retirees who live off their taxable savings accounts and Roth accounts for a few years while postponing benefits may also find they have more tax deductions from mortgage interest and medical expenses, for example, than they could normally use to offset their low taxable income during those early years of retirement. This presents an opportunity to convert IRA funds to Roth funds while paying little or no taxes on the conversion and reduce RMD's.

A major caveat: I am not a tax expert and you should consult one before making these decisions. (Keeping up with tax law is a full time job.) These are just some ideas you should discuss with an expert.

Thanks for writing!

12. I have only recently found your blog and am catching up on prior blogs. Thank you for what you do.
I very carefully weighed my Social Security options and began recently taking my benefit at age 66. My wife qualifies only for the spousal benefit which she is now taking at age 64. We don't need the money, like most people who delay. We invest it regularly in a low cost vehicle.
By age 70, even if Mr. Buffett gains zero, I will have a pot of 180k. Had I delayed that pot would be only 30k for my wife's 2 years of spousal benefits.
Furthermore if Mr. Buffett happens to outperform Uncle Sam, those gains will not be taxed as ordinary income.
Why should I or others pass up this opportunity?

1. If you read the comments above, you will find several reasons why I believe you should delay claiming.

I would recommend against your strategy to grab Social Security benefits early and invest them in the stock market because you are exchanging an ultra-safe stream of income that will last no matter how long you live for a risky stock market investment.

Your strategy will work great if your investments pay off and both you and your wife live no longer than your average life expectancy. If the investments don't pay off, then you have sold a highly valuable asset that you cannot purchase (you can only earn Social Security benefits) in order to place a bet on stocks.

Should you and your wife live longer than your average life expectancy, you would have received larger payments later in life by delaying. Social Security benefits are longevity insurance intended to help maintain your standard of living if you live a very long time. That's the way I believe they should be used, not as a source of money allowing you to increase your stock market bet.

In the event that one of you lives a very long life and the other doesn't (sorry, typically this is the wife), then by claiming at age 66 instead of age 70, you have limited your wife's survivor's benefits, as well.

I hope your strategy works for you, but Social Security benefits are the most reliable and affordable source of longevity insurance in any retirement plan and I wouldn't recommend that anyone trade them for a stock investment.