Don’t Claim Social Security Early on Fear of Benefit Cuts

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The increase in wealth associated with a delay in claiming Social Security retirement benefits rises for longer life expectancies, lower discount rates and no benefit reduction — and it can be substantial.

Investing today is tough. In my prior column, I discussed the very real possibility that interest rates could remain low for a long time, especially if the really, really long-term historical trend (going back to 1311) continues. That doesn’t leave too many great investing options for retirees today.

Here’s the thing, though: The best “investment” today for retirees isn’t even an investment at all; it’s delaying Social Security retirement benefits. While there’s been tons of research extolling the value of delaying claiming Social Security benefits, the most common claiming age for this benefit is age 62.

There’s also concerns about future cuts to benefits. Pre-pandemic estimates put the trust fund going to empty around 2034, but given what’s going on in our economy, especially with a payroll tax holiday, that estimate seems a tad optimistic.

When the trust fund goes to zero, it doesn’t mean benefits go to zero. At that point benefits would be based on taxes collected, which would reduce benefits to approximately 76% of what they are now. A possible 25% benefit reduction definitely affects the math when it comes to determining the optimal claiming strategy.

I personally can’t see benefits ever being cut for anyone already receiving them, but I do think it’s likely future generations get less. Older Americans are really good at voting, and reducing the income for current retirees, many of whom rely predominantly on Social Security for retirement income, seems a bit unsavory.

For this article I ran a quick analysis, which I detail below, exploring how delaying a claim for benefits from age 62 to 65 would be affected by varying real discount rates, life expectancies and potential cuts in Social Security retirement benefits, where the cuts are assumed to impact payments at age 65.

Long story short: Even if benefits are cut, when you factor in today’s environment of incredibly low bond yields, with the real yield on 10-year Treasuries at -1%, delaying claiming still is likely the best strategy for the vast majority of retirees.

Social Security Retirement Benefits

Social Security retirement benefits are based on averaged indexed lifetime earnings. This is how these benefits change by claiming age, assuming a $10,000 benefit at age 67 (full retirement age):

• Age 62 — $7,000 benefit
• Age 63 — $7,500 benefit
• Age 64 — $8,000 benefit
• Age 65 — $8,667 benefit
• Age 66 — $9,333 benefit
• Age 67 — $10,000 benefit
• Age 68 — $10,800 benefit
• Age 69 — $11,600 benefit
• Age 70 —$12,400 benefit

The older you are when you claim Social Security retirement benefits, the more the payment increases.

The benefit at age 70 is 77% larger than the benefit at age 62. Even delaying claiming from age 62 to 65 results in a benefit increase of 23.8%, which is an annual benefit growth rate of 7.4% per year.

When trying to analyze the benefits associated with delaying claiming Social Security benefits, it’s important to realize that you cannot “buy” anything like Social Security retirement benefits today.

Social Security retirement benefits are explicitly linked to inflation (something no private annuity offers today), are tax-favored and include survivor benefits. Therefore, while it’s possible to run some quick numbers focused on benefit payments, in reality there’s a lot more to consider.

Potential Benefit of a Delay

For my analysis I assume an individual would claim Social Security retirement benefits at either age 62 or age 65, with benefits of either $7,000 or $8,667, consistent with the previous table.

The absolute numbers don’t really matter; it’s the relative difference that counts. By delaying to age 65, the benefit would increase by 23.8% (or $1,667) per year, for life. To simplify things, everything in the analysis is in real terms (i.e., today’s dollars).

I estimate the mortality weighted net present value using different key assumptions. For the retirement period, I use the average between male and female mortality rates from the Society of Actuaries 2012 immediate annuity mortality table with improvement to 2020.

I fit Gompertz parameters to the mortality curve so I can change the modal life expectancy to reflect retirees with below and above average life expectancy. I assume a modal change of -5 years for below average life expectancy and a modal change +5 years for above average life expectancy.