Most who are old enough to think about filing for Social Security (SS) have some basic understanding of the timing trade-offs. Briefly, one can file as early as age 62, but to get your “full” benefit you must wait until your SS defined Full Retirement Age (FRA). For all who collect early, benefits are reduced by an amount dependent on how early. In contrast, if you wait until after your FRA (but no later than age 70), SS will boost your benefits 8% per year. As a result, between the ages 62 and 70, monthly benefits increase with each additional month that one delays collecting. What you get, however, relative to what you forgo, does have variation. That variation, which leads to both more and less advantageous times to start collecting, is the focus of what follows.
Viewing Social Security as an Annuity with Options
Imagine, for the purpose of understanding, your SS benefits as a simple annuity that provides fixed monthly payments starting at age 62. While SS includes such things as inflation adjustments and survivor benefits, we will ignore those details and simply consider the payment stream. The monthly benefit one would receive at 62 depends on just two things:
- Your Primary Insurance Amount (PIA), which is the monthly benefit SS would provide if you began collecting at your FRA
- When you were born
For those born between 1943 and 1954, FRA is 66 and benefits, at age 62, are 75% of PIA. For 1960 and later birth years, FRA is 67 and age 62 benefits are 70% of PIA. Birth years between 1954 and 1960 serve to transition between those specified bookend values.
With that background, let’s return to our annuity view of SS. Rather than thinking of reductions or bonuses relative to your FRA benefit, now think of having an age 62 benefit and the option to delay start of payments anywhere from 1 to 96 months. For every month you delay, an addition is made to what you could receive in all subsequent months. In effect, you “buy” a small supplemental annuity with every forgone check. As an example, consider Jill. She was born in 1960 (FRA=67) and has a $1000 PIA. Jill’s age 62 benefit would be $700 (70% of her PIA), but if she delays benefits to age 62 and 1 month (subsequently specified using the format Years:Months), she would be exchanging her 62:0 benefit for an additional lifetime annuity equal to 5/12 of 1% of her PIA ($4.17) starting at 62:1. That corresponds to an annual income of 7.14% of her $700 “cost.”
By deferring benefits one more month, Jill could get another 5/12 of 1% of her PIA starting at 62:2. This time, however, instead of paying $700 for the additional $4.17 per month, she would be paying $704.17. The increased cost pulls the annual income down to 7.10%.
As the benefit you could collect grows with every additional month you wait, so too does the “cost” of the next incremental benefit. To compensate, SS increases the increment size at both three years before FRA and at FRA. This information is summarized in Fig. 1.
Stepping the delay in collecting benefits, month-by-month, all the way to age 70, yields the following.
Given the fixed size of the monthly benefit increase within each of the three ranges, the decreasing income as a percentage of “cost” is due to the rising benefit one is forgoing so as to get the next increase. As the plot shows, income percentage varies significantly: 6% to 8.3%.
One might wonder how such payment streams, likely about as risk free as one might find, compare to private market products. Running annuity numbers for a couple online sites yielded the following for a fixed income annuity with immediate payment start.
Only at age 70 does the private market provide something close to what SS does, and that is ignoring SS’s inflation protection and potential survivorship benefits.
Retiree Priorities Are Personal
For those who are financially conservative, concerned about a long life, and can afford to wait, delaying SS as long as possible makes sense. The assurance of larger SS benefits for the coming two, three, or even four decades provides value to such individuals. SS is their longevity insurance.
For others, present income takes priority. Many don’t have the luxury of waiting; they have bills arriving. Others may have health issues and desire benefits for as long as possible. Finally, we have those who could wait, but don’t. The latter may expect/hope to do better by collecting SS early and investing the proceeds.
Understanding the thinking that motivates cautious investors to wait until 70 to collect, and aggressive folks to start at 62, requires more than the simple annual income percentage shown in Fig. 2. We need to account for payment duration. To do so, we will calculate the Net Present Value (NPV) of the additional income streams — generated by each monthly delay in collecting SS — and compare that value to the “cost” (i.e., benefit amount not taken) to obtain the income stream.
Net Present Value
Calculation of NPV requires both a discount rate and the income stream’s duration. Everyone would agree that a dollar in hand is worth more than the promise of a dollar a year from now. The question is — How much less is next year’s dollar worth: 3%, 5%, 10%? The answer is — It depends on the individual.
People who severely discount future dollars include those who lack the resources to pay current bills. When one is wondering how to put food on the table next week, the present value of a dollar promised next year is very low. Those with health issues, who may not envision a long retirement, will also place a large discount on future dollars. When to claim SS in such situations does not require a detailed evaluation.
Our focus here is on retirees who have some money saved and want to optimize their situation. What discount rate might they apply? If a person’s investments target a 5% annual gain, that implies they place equivalent value on $100 currently held, and the expectation of $105 next year. Their willingness to exchange one for the other provides an answer to our question. Namely, a person’s discount rate should equal their accepted rate-of-return on investments.
We will perform our analysis using both 3% and 7% (net of inflation) so as to cover the range from conservative to aggressive. Income stream duration follows from an assumed life expectancy of 90 years.
Return Ratio of the Incremental Benefits
The following pair of charts were generated for FRAs of 66 and 67. The vertical scale displays the ratio of the income stream’s NPV to the cost (i.e., the SS benefit amount not taken) to obtain that income. Values less than one indicate a monthly benefit stream’s discounted value is less than the price “paid” to obtain it. Values greater than one indicate the opposite.
For the conservative investor planning for a long life, the black triangles in these two charts reaffirm the prudence of delaying SS benefits as long as possible. Only shortly before age 70, when the monthly benefit would have risen quite high, does the return ratio drop below 1.0. Taking benefits early and putting them into a 3% CD would be a losing strategy relative to delaying benefits, and that’s ignoring the inflation protection provided by SS.
For the aggressive investor, the 7% discount (red) data shows something different. The return ratio only briefly gets up around 1.0. Consequently, collecting SS early and investing the proceeds, with a targeted return of 7%, would be better financially (ignoring possible tax consequences). Such an approach, of course, requires acceptance of the possibility that returns fall short of the target.
The Moderate Investor
For both the risk averse and the risk taker, the above provides some understanding of their thinking. But what about individuals who are moderate in their willingness to accept risk, people who perhaps have their IRAs invested in mutual funds that combine stocks and bonds and can reasonably expect returns of 5% above inflation? What SS timing strategy benefits them?
Before answering that question, let’s first take a look at what claimants have historically done. Fig. 4¹ displays claiming data for 1936 to 1942 birth year women. In that age range, their FRAs were transitioning from 65 to 66 in two month increments. Among those who don’t file for benefits at 62, there is a clear tendency to wait until their FRA. (The data for men shows even stronger FRA peaks.)
(Fun Fact: The reason the initial large peak is not at 62:0, but rather at 62:1, is because you have to have been 62 for an entire month to get benefits for that month. Consequently, the first month someone can collect SS is generally the month after they turn 62.)
Those who wait until their FRA to claim benefits exemplify our middle-of-the-road group; their attitude towards investments is not driving them to either end of the claiming range. Recalculating our return ratios using a discount rate of 5%, while maintaining life expectancy at 90, produces Fig. 5 results.
Fig. 5 shows that while your FRA may be a nice target date for SS collection, since it marks when you are no longer “penalized” with a benefit reduction in the standard SS viewpoint, it’s not optimal. Starting your benefits at FRA means stopping your wait exactly when SS begins offering a better deal! In the lead-up to FRA, you are accepting 10 to 12 months with a return ratio below 1.0, and then forgoing 10 to 12 months after FRA that would provide a return ratio greater than 1.0. In fact, no matter how the Fig. 5 return ratios rise or fall through changes in life expectancy and/or discount rate, the roughly one-year period after your FRA will always provide a better return than the preceding one-year period.
Let’s bring back Jill (FRA of 67 and $1000 PIA) and consider a couple scenarios. If Jill waits until 67 to collect, she will receive $1000/month, her PIA. If instead she starts at 66½, Jill would receive $967/month. Therefore, by waiting until her FRA rather than starting six months earlier, Jill is forgoing $5802 (6*967) so as to get an additional $33/month.
Alternatively, if Jill waits six months after her FRA to collect, rather than an FRA start, she would be exchanging $6000 (6*1000) for an additional $40/month. The “costs” are close for the pre- and post-FRA waits, ($5802 vs. $6000; 3.4% difference), but the post-FRA wait adds $40 to her monthly benefit, which is 21% more than the $33 from her pre-FRA wait.
Timing variations about a person’s FRA are unlikely to make or break a retiree’s finances. Never-the-less, for everyone patient enough to wait until their FRA to collect, they should at least consider waiting another 6–12 months, thereby taking advantage of the increased monthly benefit increment that starts at FRA.
Retirement Financial Analysis
We will now put a capstone on our analysis of benefit changes with SS timing. By specifying a few more details concerning Jill’s financial situation, we can use the author’s SS&R² app (Social Security & Retirement Financial Modeling; free trial available from the Windows App Store) to evaluate Jill’s end-of-life assets as a function of SS claiming age. Let Jill’s monthly expenses, excluding federal taxes and Medicare (both calculated within SS&R), be $1500/month. She also has $200k in an IRA which provides a 5% annual return. Finally, assume zero inflation and 90th percentile for life expectancy (implies living until 98 for a women).
Fig. 6 data were obtained by stepping Jill’s SS claiming age, month-by-month, from 62 to 70. Her end-of-life financial situation is in the red if she claims SS at 62; fortunately, her assets enable her to delay claiming and thereby improve her situation.
We see in Fig. 6 that, as the delay in claiming increases, those months have a widely varying impact on end-of-life assets. The strongest gains follow the 24- and 60-month breakpoints in monthly benefit increment. The weakest, as expected, occur at the tail-end of each of the three benefit increment regions. (Note: Many of the small data variations, away from the 24- and 60-month breakpoints, have to do with whether or not IRA asset removal, driven by expenses, was significant enough to create a tax expense.)
Fig. 7 shows an SS&R Summary plot from which the Fig. 6 end-of-life asset values were obtained. (Fig. 7 data relates specifically to the Fig. 6 green dot.)
SS beneficiaries may start benefits anywhere in the 62–70 age range. Most popular is 62, but many patiently wait until their FRA — perhaps to avoid the feeling of being “penalized” for an early start. Those FRA starters, and more generally anyone not driven to the age range endpoints, should be aware there are both more and less advantageous times to stop waiting and start collecting. In particular, and to repeat what was stated previously, for anyone waiting until FRA to collect, they would likely do themselves a favor by extending their wait another 6 to 12 months and thereby take advantage of the increased benefit increment that starts at FRA.
: What Can We Learn from Analyzing Historical Data on Social Security Entitlements? Joyce Manchester and Jae G. Song, Social Security Bulletin, Vol. 71, №4, 2011.
: Social Security & Retirement Financial Modeling, eiPie Innovations, http://eipie.com/eiPie/ss&r.php