Another friend sitting three rows behind me at a baseball game once stood up in the middle of an inning and shouted, “Hey, Dirk, what is the break-even age for claiming Social Security benefits?”
Since most Americans have not saved nearly enough for retirement, when to claim is often moot. Most people need their benefits right away and can’t afford to delay them. But, if you can afford to wait, let me try again to explain why you probably should.
Here’s the comment from a reader.
“My wife and I will retire in 4 or five years at about 66. We will each have small pensions and access to a little investment income. Social Security will be the 4th revenue stream. A financial adviser really wants us to wait until 70 to claim Social Security, but I’m concerned that we will have to erode our investments during that 4 or 5 year wait. Trying to forecast what that will cost us in lost investment income vs the higher Social Security benefit when claimed later is like betting on the pig races at the fair. An educated guess, a WAG, a stab in the dark. It doesn’t help with the confidence and security we seek in retirement.” – Chris
(Isn’t it interesting how often pigs come up in my retirement blog? I need to give that some thought. Think Like a Bayesian Pig.)
Chris, I believe the reason you are not getting a satisfying answer is that you’re not asking the right question.
I deduce from your comment that you understand that if you live a long time, you will be better off financially by delaying claiming your Social Security benefits but, if you don’t live a long time, you will be better off claiming them right away.
You are having difficulty deciding whether to bet that you will live a long time or a short time after you retire. You might as well bet on that pig race because just as you have no idea which pig is fastest, you have no idea how long you will live.
Social Security retirement benefits are a form of insurance. In fact, Social Security is the commonly used term for the federal Old-Age, Survivors, and Disability Insurance (OASDI) program. Before we delve into old-age insurance, let’s consider a more familiar form of insurance, auto insurance.
By car insurance industry estimates, you will file a claim for a collision about once every 17.9 years. That isn’t terribly interesting information because you might not be average. You might go 30 years without an accident or have one tomorrow. Planning your retirement or buying insurance based on averages is a very serious fallacy. Insurance should protect you from catastrophes, not from average losses.
You might ask – though, you probably don’t — why you should pay thousands of dollars each year for car insurance when there is a 50% chance that you won’t have an accident for nearly 18 years.
The answer is simple. A car accident could be financially catastrophic. Without insurance, it might cost you $40,000 to replace a car, not to mention hospital bills and a million-dollar liability judgment. So, we pay insurance premiums hoping that we never need to file a claim in order to avoid a potentially catastrophic outcome.
That’s the definition of insurance. We accept a small, guaranteed loss (the cost of insurance premiums or delayed Social Security benefits) in exchange for protecting us from an unlikely but potentially catastrophic loss.
A reader asks: Is claiming Social Security benefits harder than betting on pig racing?
How does that relate to delaying Social Security benefits, a.k.a., Old-Age, Survivors, and Disability Insurance?
Delaying Social Security benefits is like purchasing additional longevity insurance. The equivalent premium payment is forgoing some Social Security benefits that we would otherwise receive if we claimed at age 62.
The equivalent catastrophic loss in retirement is becoming impoverished when we are very old. Delaying claiming Social Security benefits is a way to buy more longevity insurance. Said differently, it’s a way to transfer some guaranteed income early in retirement to provide more income later in retirement should we live to be very old.
This is the catch, of course. We don’t know if we will live a very long time and, if we don’t, we will have given up those early benefits for no reason, like buying auto insurance and never needing to file a claim.
When we buy auto or life insurance, we don’t know if we will have a huge accident or die while dependents still need our job income, either. We may be paying those premiums with no return and, in fact, we hope we are. We don’t make a bet on when those things might happen, we buy insurance to protect ourselves if they happen because an uninsured loss could be really bad. The alternative is to hope we’re lucky.
Short retirements are cheaper than long retirements. Let’s assume that you will need $50,000 a year to cover your living expenses after you retire. A retiree who leaves the workforce at age 62 and dies at age 67 will need $250,000 to fund retirement. A worker who retires at age 62 and lives to age 92 will need $1.5M to fund retirement.
(Both numbers are actually smaller than this when we consider the time value of money, but let’s keep it simple for now.)
In other words, if you don’t live long, your retirement will be relatively cheap and if you become quite old it will be relatively expensive.
When you delay claiming Social Security benefits and only live a short time, you will reduce your income but it won’t hurt much because you will also have a cheap retirement. If you live a long time, you will increase your income by delaying claiming and you will need the additional income because you will have a long, expensive retirement.
Now, let’s look at the alternative bet of claiming your benefits early.
If you live only a short time after retiring, you will have maximized your Social Security income for a scenario in which your retirement wasn’t that long or expensive. If you live a long time, you will have minimized your Social Security income for a scenario in which your retirement is relatively expensive.
The goal of delaying claiming your Social Security benefits is to make sure you have more money in the worst case scenario, living a very long, very expensive retirement. It’s like taking some small, certain losses by buying car insurance to avoid an improbable catastrophic loss if you have the big accident.
Now, Chris, I suspect that you’re trying to place a bet on whether or not you will live a long time. If you’re healthy, you can’t know how long you will live. If you’re going to place that bet, you’re correct, you might as well bet on the pigs.
A better way to frame this decision is as a purchase of additional longevity insurance to protect your household against a very long, expensive retirement instead of framing it as a bet on how long you might live.
Your comment says, “It doesn’t help with the confidence and security we seek in retirement.“
If it’s confidence and security you seek, buy insurance. You get that by delaying claiming Social Security benefits as long as you can afford to do so, thereby taking the catastrophic scenario, inadequate income in old age, off the table.
You also say, “Trying to forecast what that will cost us in lost investment income vs the higher Social Security benefit when claimed later is like betting on the pig races at the fair.”
You’re trying to compare two very different things. Your investment portfolio is a liquid asset with no longevity guarantee — you can outlive your portfolio. Annuities and Social Security benefits are illiquid but they will provide income if you live to 120. You probably need both.
Like not knowing how long you will live, you can’t know how much investment income this decision will cost you. You can only guess. If your investments go south, you will have been much better off with more Social Security income, and vice versa.
Since you don’t know how long you will live or how your investments will turn out over the long term, the trick is to make sure you have an adequate floor of Social Security benefits, fixed annuities and the like to protect against a very long life and poor investment results. Invest what’s left for upside potential and liquidity. That will tell you whether delaying benefits is a good strategy for your personal situation.
It’s a somewhat complicated optimization, but presumably, that’s why you asked your advisor for help in the first place.
Delaying claiming Social Security retirement benefits is the most cost-effective longevity insurance you can buy. If you think of it as insurance and not a bet on how long you will live, you may find it makes more sense than pig races.
“. . . no one knows the best asset allocation in advance“, Does The 4% Rule Work Around The World?, Wade Pfau.
NOTE: My blog seems to be having problems accepting comments, as it does from time to time. Sorry, I hope to have that corrected soon. Meanwhile, you may need to click the “comments:” link in the very last line of the post that begins “
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 How Many Times Will You Crash Your Car? Forbes magazine.
Originally posted at http://www.theretirementcafe.com/2017/09/social-security-claiming-and-pig-races.html