Sophisticated analyses take into account the tradeoff ofreceiving no income during the deferral period and moreincome later in retirement. The losses are particularly acutefor women and healthier Americans (often those with higherincomes) who receive the same annual income increase fromdeferral but can expect to receive this income over more yearsthan the average American, as they tend to live longer.
Claiming early can be tempting for retirees who are worriedabout the solvency of Social Security. As Boston Universityeconomics professor Larry Kotlikoff has pointed out, if SocialSecurity income is eventually cut (which is unlikely) theincome of those who claim early will be cut by the same percentage as those who claimed later.
If benefits get a 23% cut in 2034, the average present value(or PV) of payments for a male claiming at 62 is $678,124, and$764,084 if he claims at 70. Cutting benefits earlier than 2034will only increase this difference. Without a benefit cut, thedifference between claiming at 62 and 70 is $131,951 ($818,747vs. $950,698).
Advisors and Present Value
As Kotlikoff’s present value calculations demonstrate, getting
the claiming decision right can add the equivalent of a six-fig-
ure windfall to a retiree’s balance sheet. Advisors who cling to
less accurate methods, such as the breakeven age, to evaluate
the benefits of various claiming options may shortchange their
client by tens of thousands of dollars if they fail to consider the
value of larger income payments made later in life.
Insurance companies price the cost of creating an annuitybased on the present value of mortality weighted future payments. If the probability that a healthy woman will be aliveat age 90 is 50% (according to the Society of Actuaries tablefor annuity buyers), then the value of a $30,000 payment willbe $15,000.
Discounting the current rate on inflation-protected U.S.government Treasury bonds ( TIPS), which recently was -0.5%,the present value of this payment is exactly $17,000. In a market that prices inflation-adjusted payments with a negativediscount rate, the value of Social Security is higher than whenTIPS rates are positive.
An advisor evaluating deferral strategies should thinklike an insurance company when estimating the value ofclaiming at different ages. How healthy is my client compared to the average American? If they’re healthy, thisincreases the present value of any claiming strategy thatincreases future income.
How healthy (and what age) is their spouse and how muchwill the deferral affect the spouse’s income? What is the current market rate of return on inflation-protected securities?
Higher Social Security income is worth more when the market places a greater value on inflation protection and nominalinterest rates are low.
Social Security COLA: What’s Working, What’s Not
The inflation protection provided through Social Security is anoften overlooked but important benefit that makes it a valuabletool for funding basic retirement expenses.
How are Social Security benefits adjusted for inflation, andcan we expect these annual income increases to continuein the future? Does the inflation adjustment do a good jobof increasing income when retirementexpenses rise?
The expected shortfall in theSocial Security trust fundmeans that policymakers willsoon be looking for waysto shore up the system’sfinances.
Reducing inflationadjustments offers thedual political benefit ofavoiding a reduction inthe size of Social Securitychecks and reducing the sizeof future payroll tax increases.
Should advisors be worried that this impor-
tant benefit will disappear?
Social Security recipi-
ents will receive a 1.3%
ment (COLA) to their
monthly benefits beginning
in January 2021. The aver-
age Social Security retire-
ment benefit in 2020 is
Therefore, the “average”
retiree will receive an approx-
imately $19.50 increase in
their monthly benefit check, or
$234 for the year. This increase
is on top of the 1.6% increase
Social Security benefits only risewhen prices go up; in years with lowprice inflation, they remain steady.