Social Security Timing II (Post FRA Refinements)
The author’s Medium article, Social Security Timing, considers Social Security (SS) from a different perspective. Rather than thinking of having a Full Retirement Age (FRA) benefit, to which deductions apply if you start benefits early, SS is viewed as an annuity that starts at age 62, but with a unique feature. One can delay its start, month by month, and in effect purchase a small supplemental annuity, at the price of a month’s forgone benefit, for each month up until age 70.
Given that viewpoint, Social Security Timing does what anyone should do when considering an annuity purchase — evaluate benefits relative to cost. The benefit, the incremental monthly payment obtained by not taking a given month’s payout, is valued by its Net Present Value, or NPV. The cost is the forfeited payout. The ratio of NPV to cost, also referred to below as the return ratio, provides a single number cost-benefit assessment for each month between the ages of 62 and 70. Graphing those numbers allows us to quickly see when the benefits exceed the cost, and when they don’t.
Social Security Timing: A Confession
When starting benefits between 62 and your SS defined FRA, your very first check reflects all delay supplements. Although the graphs provided in Social Security Timing also assume immediate credit for any months delayed after FRA, actual benefit calculations are a little more complex. That complexity, properly considered, provides a logical basis for starting SS benefits not at FRA, the second most popular time to begin benefits, but rather in the month of January, six to eighteen months after FRA.
Delayed Retirement Credits (DRC)
Time to delve into the details. After FRA, a person earns a DRC for every additional month they delay collecting. Each post-FRA month without benefits, and thus each DRC, is worth 2/3 of 1% of the person’s Primary Insurance Amount (PIA). The complexity in calculating post-FRA benefits arises because DRCs only get included in benefit calculations at certain times: January (following the year earned), and at age 70.
To illustrate, meet Jill. Her PIA is $1000 and, with a July 1960 birthday, her FRA is 67. If she begins collecting benefits when she reaches FRA, she will receive her full benefit, $1000, for July 2027. Nothing complex yet.
Now let’s suppose Jill wants a 2% benefit bump. She can get that by starting benefits in October, three months after her FRA. When she opens her first check, received in November (checks for a given month are sent out the following month), it’s only for $1000. What about her 2% boost, the extra twenty-bucks for which she forfeited three months of benefits?
Well, Jill’s extra $20/month will not arrive until February 2028. Her three DRCs (July, August, September) don’t figure into her benefit calculation until the following January (February check).
Now suppose Jill had told SS she wanted to delay 1½ years after her FRA and begin benefits in January 2029. Her first check, incorporating six DRCs from 2027 and twelve from 2028, would be for $1120 and arrive in February 2029. With a January SS start, all her DRCs apply immediately.
As a result of these DRC details, the NPV to cost ratios shown in Social Security Timing are only approximately correct in the post-FRA period. After reaching your FRA, the monthly benefit you could receive during a given calendar year, and thus your “cost” of delaying benefits another month, is fixed within that year. However, as you progress through a calendar year, and the time interval shortens between when a monthly benefit is forgone and the January beginning of the associated benefit supplement, the payment stream NPV rises. Consequently, the actual NPV to cost ratio trends upward within a calendar year. As soon as a new year begins, however, and potential benefits rise with the inclusion of the prior year’s DRCs, the “cost” of continuing the delay also rises and the NPV to cost ratio suffers a drop.
Fig. 1 shows a revised version of Social Security Timing’s Fig. 5. Post-FRA, we see the NPV/cost uptrend within a calendar year and the sharp January drops. Birth month also has an impact, albeit one of secondary importance. The chart has been color-coded to highlight the return ratio impact — green for positive and red for negative.
And So?
What do these details mean? In short, anyone considering an FRA SS start should also evaluate waiting until either the first January after their FRA, or perhaps even the subsequent January if born in the second half of the year. Those months after FRA always have a higher return ratio than the preceding twelve months.
Making the Abstract Tangible
The return ratio, a benefit stream’s NPV/cost, can help inform SS decisions, but is a bit abstract and does not readily translate into something basic like spendable income. Fortunately, SS timing decision consequences can be made tangible by evaluating their impact on a person’s monthly budget (i.e., how much they can afford to spend each month). How do we determine Jill’s allowable budget? We simply need to provide a little additional financial data and then exercise the author’s SS&R¹ app (Social Security & Retirement Financial Modeling; free trial available from the Windows App Store).
Assume zero inflation and $200k in a Roth IRA providing a 5% annual return. Also, let’s say Jill desires a $50k end-of-life asset cushion as insurance against exceeding her age 90 planning target. Calculating how much she can afford to spend each month, as a function of when she starts collecting, gives us Fig. 2 (results for both January and July birthdays show birth month impact).
Budget Takeaways
First, Jill’s SS start age has little budget impact. Her total budget range is only about $10. That range would scale up with a larger PIA, but given her investment return rate and life expectancy, the range will always be a very small fraction of her budget.
Why such a small range? The answer lies in Fig. 1. The combination of a 90-year life and a 5% rate-of-return/discount rate produces return ratios that are evenly balanced about neutral. Periods with a return ratio greater than one, causing the monthly budget to trend upward, are balanced by periods where the opposite is true. While the limited budget range means no decision is disastrous, it still makes sense to choose a good month, rather than a poor one, to stop waiting and start collecting.
A second point concerns how long Jill’s $50k cushion extends her solvency if she has the good fortune of living beyond her expected 90 years. The longevity labels show that the longer she waits to collect, and thus the greater the portion of her monthly budget provided by SS benefits, the slower she would burn through her cash reserve. That is the longevity insurance aspect of SS that one gets with a delayed start. The cost, obviously, is the consumption of other assets while waiting to start SS.
When the Return Ratios Are Not Balanced
A ninety-year life expectancy and a 5% discount rate generated a reasonably well-balanced return ratio. A change in either parameter can unbalance the ratio and cause either an upward or downward tilt in the monthly budget curves. Figures 3 & 4 show the return ratio and budget results after both adding and subtracting five years from life expectancy. For anyone expecting to live 85 years or less, just a 5% investment return (after inflation) drives most return ratio values below 1.0. Those conditions suggest an age 62 SS start. Alternatively, with a life expectancy of 95 or more, the return ratio is predominantly greater than 1.0 and 69 or 70 looks like the best starting age.
Figure 5 provides the equivalent of Fig. 3, but now varying the discount rate. Given a life expectancy of 90, discount/return rates of 4% or less imply one should wait until at least 69 to start SS. However, with discount/return rates of 6% or more, starting benefits at 62 is justifiable. Relatively modest changes in either life expectancy or discount/return rate can readily unbalance our budget curve with its teeter-totter behavior.
Conclusion
SS timing involves two key parameters concerning the future:
1. Your rate-of-return/discount rate
2. Your life expectancy
As we saw earlier, a 90-year life expectancy and a 5% rate-of-return/discount rate provide a balance point for SS timing. Anything that puts a question mark on living into your 90s, or anything that pushes up the value of a dollar today relative to one next year, gives impetus for starting SS at 62. Those burdened by health issues, those struggling to pay current bills, along with those confident the stock market will continue behaving as it has in the past can all justify joining the roughly 35% of non-disability claimants who start SS at 62.
This post is not for “SS at 62” people, but rather everyone looking to start either at or after FRA. Just like those starting at 62, these people also have their reasons. Perhaps they have good health and long-lived parents. Perhaps they are financially conservative or concerned about a market crash. Perhaps they are using SS as a reliable financial base that enables aggressiveness with other investments. Or, perhaps, they just don’t like the idea of taking a penalty for starting “early.” No matter the reason, for anyone planning on waiting until FRA, they would be wise to take a step back and consider two other options: either the first January after their FRA (birthday early in the year), or the second (birthday mid-year or later). Budget differences may not be large, but doesn’t it seem silly to stop your wait just when SS starts offering a better deal?
References:
[1]: Social Security & Retirement Financial Modeling, eiPie Innovations, http://eipie.com/eiPie/ss&r.php
