What You Need to Know
- The benefit retirees get for delaying their Social Security claim does not increase at a consistent rate; it rises in steps.
- The benefit of claiming after step years is much larger than other years.
- This strategy is particularly valuable for women.
The bonus retirees get from waiting to claim Social Security income benefits increases in two steps. These steps, originally created as a shortcut to simplify benefit calculations, result in differences as high as $10,000 in the incremental value of waiting an additional year to reach each new step.
Claiming before the valuable step-years can be a costly mistake. Workers who claim at full retirement age lose a significant amount of wealth by not taking advantage of the most valuable 8% one-year step increase.
A worker in 2022 who is eligible to receive $20,000 in Social Security income benefits at age 62 can increase her income by waiting to claim up to age 70. The percentage increase is 5% each year up to age 64. It steps up after her 64th birthday to 6 2/3% each year up to her full retirement age (67 for someone born in 1960). After reaching 67, the bonus steps up again to 8% a year until age 70.
The delayed claiming income step formula is supposed to be actuarially fair. Because the government expects to make more stepped-up payments to a 63-year-old than a 68-year-old, the percentage increase from waiting an additional year is lower.
In reality, the formula isn’t actuarially fair. The percentage increase from deferral should rise gradually each year instead of increasing at ages 64 and 67. These two steps mean that the gain from waiting an additional year is higher the first year of each step, and understanding how the amount varies presents a planning opportunity.
The actuarially fair value of delayed claiming can be calculated by taking the present value of the higher future income payments discounted at current rates for Treasury inflation-protected securities (TIPS), and then subtracting the year of income lost by delayed claiming. A 62-year-old who delays claiming to age 63 gives up $20,000 this year, but gets an additional $1,000 of inflation-adjusted income per year for the rest of her life.
How long will she live? We can use mortality tables to estimate the value of future income. Each payment is then multiplied by the probability that she will be alive to receive the future payment.
Social Security has its own (SSA) mortality table that estimates the lifespan of average Americans, but this isn’t relevant for most higher-income financial planning clients who live significantly longer. This means they’re more likely to be alive at age 90 or 95 to cash their Social Security check. The higher probability of being alive makes the higher income payment from delayed claiming more valuable.