What You Need to Know
- Strategic claiming can add $100,000 or more to an investor’s wealth that can be used either for income or legacy goals.
- Most retirees are able to increase their wealth through delayed claiming.
- Social Security should be considered part of the fixed income assets within a client’s investment portfolio; delayed claiming allows an advisor to increase stock allocations.
A high-earning retiree with a $2.5 million investment portfolio holds 20% of their wealth in Social Security. Strategic claiming can add $100,000 or more to a healthy investor’s wealth that can be used either for income or legacy goals.
Advisors can earn easy investment alpha through strategic Social Security claiming. Too many investors claim Social Security when they retire, not realizing the impact early claiming has on retirement wealth, taxation, spousal income, and even optimal asset allocation.
Claiming too early can significantly reduce a retiree’s holistic balance sheet wealth that includes expected future income streams such as pensions and Social Security income benefits.
After all, a retiree would have to pay hundreds of thousands of dollars to receive a fairly priced stream of future income, and the income will reduce the amount that will need to be withdrawn from savings to fund retirement spending. The value of future guaranteed income is based on discount rates of safe investments and the probability of being alive to receive the money.
In a recent article on ThinkAdvisor, I addressed the importance of paying attention to the two Social Security income benefit steps when making decisions about whether to delay claiming. These steps affect the marginal increase in wealth from waiting one more year, but many don’t recognize how large the expected contribution of Social Security represents to total retirement wealth.
Claiming rules based on outdated mortality expectations and overly optimistic return expectations on inflation-protected income mean that most retirees increase wealth through delayed claiming.
With the help of David Blanchett, head of retirement research at PGIM, we can use mortality tables and market prices of inflation protected bonds to estimate the portfolio value of Social Security at various claiming ages for men and women in average and excellent health. Values will be greater for healthier retirees and women because they can expect to live longer and cash more checks.
A single retiree born in 1960 who is eligible to receive a $20,000 income benefit at age 62 can expect to receive between $385,568 in present value of total Social Security benefits (for a man in average health who claims at age 62) and $594,063 (for a healthy woman who claims at age 70).
The values represent a base case scenario that could be considerably higher for workers who have a younger, lower-earning spouse that can expect to receive a higher lifetime benefit.
If a healthy man claims Social Security at age 62, an advisor should estimate the balance-sheet value as at least $458,038. If he waits to claim until age 70, the present value of Social Security income benefits is $549,305. By delaying to age 70, an advisor can help a client earn their client a risk-free annual 2.3% increase in the value of retirement wealth.
Issues With Delayed Claiming
Delayed claiming means forgoing a source of income before age 70. This presents opportunities for strategically spending down retirement savings to optimize tax efficiency in the bridge period between 62 and 70.
Advisors should pay close attention to marginal tax rates (and IRMAA thresholds) and withdraw strategically from traditional IRA accounts while also spending down tax disadvantage investments such as non-qualified bonds.