Starting Social Security: Consider the risk of living too long

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Deciding when to begin taking Social Security benefits is anxiety-inducing for many workers. An understandable impulse might suggest beginning as soon as possible to collect the maximum number of payments since the payments cease at death. Indeed, nearly one third of Americans choose to start at 62. But from a financial perspective, the biggest risk is not dying too soon but living too long, severely constraining one's standard of living in later years.

An interesting paper from the National Bureau of Economic Research suggests that 75% of all workers and more than 90% of middle-aged and younger individuals would maximize their lifetime standard of living by waiting as long as possible to claim Social Security, regardless of their level of income or wealth.

The research by David Altig of the Atlanta Fed, and Laurence Kotlikoff and Victor Ye from Boston University, confirms the conclusion of other studies but is the first to employ a complex modeling application to quantify the benefits of optimizing Social Security. The researchers utilized consumer finance data from the Federal Reserve along with information on other benefit programs and federal and state taxes to estimate the present value of lifetime discretionary spending (household spending by choice other than essentials like rent and food). Total discretionary spending can be viewed as a proxy for a household's standard of living.

But instead of average life expectancies, the model optimized Social Security using the maximum age of life to incorporate the much greater financial risk of outliving the average, a potentially catastrophic event for the unprepared. The results were startling: 91% of workers aged 45-62 would benefit by maximizing Social Security, increasing their median lifetime discretionary spending by $182,370 in 2022 dollars, and boosting their living standard by 10. Even among workers in the 63-69 bracket, 84% would gain by waiting and enjoy a median increase of $92,218 in lifetime discretionary spending.

Starting Social Security benefits was intended to be actuarially neutral. That is, if one lived to their exact theoretical life expectancy, they would receive the same benefits in current dollars no matter when they begin. A smaller monthly payment over more years would be equivalent to a larger monthly check for fewer years. But much has changed since the original program assumptions.

Life expectancies have increased substantially since the Social Security Act. In 1940, men who had attained the age of 65 were expected to live another 12.7 years, while women were projected to live 14.7 years. By 2019, that runway had expanded to 18.2 and 20.8 respectively, a 40% increase in additional post-retirement years. This substantial improvement in longevity suggests that workers should reconsider some basic assumptions in ciphering when to pull the trigger.

The Social Security Act of 1935 created supplemental retirement income beginning at age 65. In 1956, women were allowed to claim reduced benefits at age 62, and by 1961 all participants had the option to start three years early. Responding to the last existential threat to the solvency of the system in 1983, Congress passed reforms suggested by the Greenspan Commission, gradually raising the age for full benefits (the "full retirement age") from 65 to 67 and adopted the current penalty and reward schedule.

Workers may elect to begin receiving Social Security payments as early as age 62, but their monthly check is reduced according to an arcane formula: 5/9 of 1% per month for the first 36 months plus 5/12 of 1% for each additional month before full retirement age. The bottom line is that starting at 62 means taking a 30% cut versus full benefits. That's the stick.

The 1983 rework also dangled an appetizing carrot for workers willing to delay. A retiree's monthly check is increased by 2/3 of 1% for every month payments are delayed, or 8% per year up to age 70, yielding an extra 24% by holding out for the full three years.

The average Social Security payment at full retirement is $1,827 in 2023. A worker opting to begin at age 62 would receive only $1,278 per month, while patience until 70 would result in a $2,265 monthly check. Furthermore, annual cost of living increases apply to the first payment amount, compounding the benefit of waiting.

The difference between starting early and waiting it out is huge. Benefits owed to those who delay until 70 are 76% larger, adjusted for inflation, than if they had started at 62.

The study concludes most workers would benefit by withholding filing until age 70, but in practice, only 6% actually do. One third of adults begin at 62 and only 30% make it to their 65th birthday, potentially leaving a sizeable pile of chips on the table.

The benefits of maximizing are greatest in absolute terms for the highest income earners, but even the poorest quintile would realize a median 15.9% boost in lifetime discretionary spending by delaying. The authors recognize the cash flow constraints for lower-income workers and suggest legislating a reasonable incentive like allowing early claim to, say, 25% of benefits and delaying the remaining 75% to age 70.

The magnitude of the retirement savings crisis is well documented, and two of every five Americans depend upon Social Security for more than half their retirement income. Encouraging workers to maximize their lifetime benefits would make a material difference in the lives of millions of American retirees.

Christopher A. Hopkins, a chartered financial analyst (CFA), is co-founder of Apogee Wealth Partners.

  photo  Contributed photo / Chris Hopkins