Psst, wanna buy an inflation-protected annuity for a bargain price? Sounds too good to be true? Well, it does come from an entity that has a few balance sheet and accounting issues. But it does have a pretty good business model—such as being able to print its own money to make annuity payments and throw customers in jail if they don’t pay their bills.
Yes, one of the best sources of annuitization income for retirement is the federal government. As with many government programs, Social Security rules are complicated—but knowing them gives you access to some pretty sweet deals. Advisors are waking up to the benefits of helping clients maximize their retirement income strategies by wading through arcane Social Security rules.
Social Security claiming strategy is a game between you and the government, or, more accurately, between you and the taxpayers. Taxpayer advocates should be encouraging single obese smokers to claim at age 70, and fit, married, well educated, high earners (who probably look more like financial planning clients) to claim early. That’s because rules created for the Ozzie and Harriet generation still apply for today’s retirees, and because what is actuarially fair for the average American may be a bargain for you.
First, the basics. Social Security retirement benefits are based on the highest 35 years of wage inflation-adjusted earnings. The benefit amount is highly progressive, meaning that the benefit increases quickly up to a set amount, and then more slowly at “bend points” beyond that amount up to a 2012 maximum full retirement age benefit of $32,851.
You can claim at age 62, but full retirement age is now 66. If you delay claiming between 62 and 70 you get a higher benefit for each year you wait. Remember Ozzie and Harriet? Social Security is designed for a primary earner (husband) and a housewife who is entitled to a spousal benefit that she can claim at age 62 or delay until 66 for a full 50% of the primary earner’s benefit.
How does claiming age affect Social Security benefits? Let’s assume your income at full retirement age is $2,000 per month. Your benefit falls to 75% of that amount, or $1,500, if you claim at 62 and increases by 5% if you wait until 63 and then by about 7% each year up to age 66. After full retirement age you get an extra 8% per year. That’s $2,640 per month if you can wait until 70. Spousal benefits also are reduced if claimed earlier than age 66.
Should a retiree claim at 62? Probably not. Stanford economist John Shoven and his co-author Sita Slavov estimate that everyone is better off waiting until 70 to claim Social Security if real, after-inflation interest rates are zero—which is about the market rate right now for inflation-adjusted bonds and annuities. So if you’re thinking about buying an inflation-adjusted income annuity, don’t do it until you’ve delayed claiming Social Security.
Singles should wait until 68 or 69 if they apply a discount rate of 2.5% to 4.5% to benefits—anything higher and they should claim at 62. Married couples should only consider claiming before 70 if they discount earnings above 6% after inflation. Can you find them another safe investment paying a real 6%? All these scenarios are based on average mortality, so a healthy client will have even more incentive to delay.
The biggest obstacle to implementing an optimal claiming strategy may be your client. A new study by Owen Haaga and Richard Johnson of the Center for Retirement Research finds that most retirees born in the 1930s claimed Social Security at age 62—the first year of eligibility. That fell to 46% for retirees born in the 1940s who were also far more likely to delay past 65. An advanced degree also doubles the probability of claiming at age 65-plus compared to having less than a high school degree. So younger, better educated clients are more open to delayed claiming.
Much of the resistance to claiming later in life is the persistent belief that Social Security will go broke and renege on its obligations. Convincing a client to delay is often the first step in developing a strategy. According to Andrea Eaton, a financial planner at Cornerstone Wealth Advisors inMinneapolis, “most Americans’ first thought is to begin claiming at age 62 or the full retirement age, but we have been able to change most clients’ minds.”
A decrease in payment size down the road is possible, but as long as workers keep contributing to Social Security the checks won’t stop. Taxpayers have been paying more toward Social Security than is paid out to beneficiaries (there was a $55 billion deficit in 2012). This excess went into the so-called Social Security trust fund, which can then be used to pay future retirees. The trust fund will continue to grow until 2021, and won’t be depleted until 2033. After 2033, there could be a 23% cut in benefits according to current rules.
A big future haircut for retirees is hard to imagine. Politicians have been burned at the stake for suggesting even modest increases in retirement age or benefit cuts. Even a more realistic cost of living increase (the chained CPI) was branded a vicious attack on seniors with promises of retribution for any politician who dared vote for it. Reform will likely include a reduction in benefit growth, higher taxes and increasing the future age of eligibility. But Social Security isn’t going away.
The Spousal Benefit
The spousal benefit underlies many of the most valuable and complex claiming strategies used by advisors. I can usually make it through about 30 seconds of a Social Security claiming strategy discussion before my eyes start glazing over. So I asked Amanda Lott, a wealth advisor for RegentAtlantic Capital inMorristownN.J., and expert in Social Security claiming rules, to give me a primer on how advisors can make the best recommendations.
Lott begins by presenting a scenario where a client claims at 62 and then compares that to the amount of benefits a retiree would receive from an alternative strategy by age 85. Not worrying about discounting higher future benefits makes sense since they will rise with inflation. Lott says that “even if you just do an aggregate sum, it’s several hundred thousand dollars that you leave on the table” by claiming too early. Another strategy is to estimate the breakeven age at which benefits from a delayed strategy will be higher. Since the likelihood that one spouse will still be around at age 90 is 40%, this can be a compelling illustration.
Academic studies have shown that married couples receive the largest gains from creative claiming strategies. That’s because the lower-earning spouse is both entitled to the larger delayed Social Security payment upon the death of the breadwinner and to receive a larger spousal benefit when the breadwinner is still alive. A recent analysis showed that a married couple received a 70% larger lifetime benefit just by deferring from age 62 to 63.