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Do 401(k) 'Bridges' Help Retirees Maximize Social Security?

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Should clients drawdown retirement savings first, as a “bridge” to delay taking Social Security until age 70?

While this idea has been around for some time, a recent study by the Center for Retirement Research at Boston College (CRR) looked at taking automatic withdraws from 401(k) plans from ages 60-69 before touching Social Security benefits.

The study — How Best to Annuitize Defined Contribution Assets — by CRR Director Alicia H. Munnell, as well as researchers Gal Wettstein and Wenliang Hou, also compared the 401(k) withdraw plan to using some of that money to buy immediate and deferred annuities.

The research aimed to find a strategy to set withdrawals from retirement savings so people don’t outlive their resources. It also examined how few people wait until age 70 to take Social Security: only 5% of men and 7% of women.

Plus, just 23% of men and 16% of men wait until their full retirement age (or FRA). A large population — 35% of men and 39% of women — begin taking Social Security at age 62, which cuts their benefit dramatically. It is estimated that claims taken at age 70 are 76% higher than those taken at 62.

Thus, the study looked at how using 401(k) plans as default payments for those 60-69 could equal what they would be getting if they were taking Social Security at the FRA.

“The expectation is that providing a temporary stream of income to replace the Social Security benefit would break the link between retiring and claiming,” the authors stated.

Comparing this strategy to immediate and deferred annuities, they found the 401(k) drawdown plan was “the clear winner,” at least for median households; the success overall is tied to wealth distribution.

For higher-wealth households, “the deferred annuity strategy is again competitive, edging out the Social Security bridge options,” the authors said.

However, depending on required minimum distributions that hit at age 72, “the deferred annuity remains a very poor choice, for both median- and 75th percentile wealth households,” the study found.

Expert Review

Both Michael Finke, professor of wealth management at The American College of Financial Services, and David Blanchett, Morningstar’s head of retirement research, support delaying taking Social Security benefits.

“Social Security benefits aren’t affected by interest rates (and haven’t been updated for improvements in life expectancy in a long time) so delaying is — comparatively — a lot more attractive than buying a private annuity,” Blanchett noted in an email. “Should interest rates increase dramatically, that wouldn’t necessarily hold.”

The Morningstar retirement expert added that Social Security still beats deferred annuities given “competitive rates, tax advantaged nature of the benefit, it’s link to inflation, spousal benefits, etc.”

Finke agreed with delaying Social Security benefits but was more open to annuities than the study, which stated that “annuities are expensive for the average person.”

He noted in an email that an inflation-adjusted income annuity “is especially attractive for higher-income clients who have made significant gains in longevity over recent decades,” referring to findings that the wealthier are more likely healthier thus have longer lives.

“This creates an opportunity for healthy retirees to buy annuitization at a below market price,” Finke explained.

Also, a deferred annuity “can be even more efficient than delayed Social Security,” he said. “I consider deferred annuities in the form of a qualified longevity annuity contract to be a ‘no-brainer’ for a healthy retiree. They get the efficiency of a deferred annuity and a tax break because they don’t have to pay RMDs on up to $135,000.”

Although the study states that the Social Security bridge option “would not require any new legislation or any new formal bureaucratic structure, not does it involved contracting with an insurer,” Blanchett is not so sure it’s that easy.

He doesn’t disagree with the strategy, but he does question the implementation: “For example, they mention using it as a default. I’m not sure how that plan would work. Plan sponsors don’t have complete wage history … [and] they don’t have complete information on a participant’s complete situation, so I see lots of practical roadblocks to any kind of product here.”

Finke noted that his research shows that “annuity income payments are incredibly competitive right now compared to conventional bond investments,” adding that ideally retirees could substitute a portion of their bond assets for immediate and deferred annuities.

“Also, the bridge approach can take advantage of a client’s lower marginal tax bracket before RMDs begin. This so-called ‘tax-bracket management’ is an important way to minimize the expected taxes paid from a traditional IRA,” Finke said.


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