Retirement
Delaying Social Security Benefits Allows You to Transfer More Risk
Retirees can choose to start their Social Security benefits at any age from 62 to 70. Each month of delay leads to higher monthly benefit payments for as long as the retiree lives. About 50% of men and 60% of women take Social Security benefits starting at age 62. Is it wise for half of all retirees to pass up the opportunity to receive higher benefits?
Delay Boosts Benefits
If you reached age 62 in 2004 and had a work record that gave you the maximum Social Security benefits, your payments beginning in that year would have been $1,414 per month. By 2008, cost-of-living adjustments would have raised your monthly benefit to $1,598. If you waited until age 66, you received $2,185 per month, which is over 36% higher than $1,598. Each year of delay between ages 62 and 66 added about 9% to the amount of your benefit payments. Delaying the start of benefits beyond age 66 will increase the payment amounts almost as rapidly.
Social Security benefits, regardless of the age you begin receiving them, allow you to transfer to the government two types of risk: inflation risk and the risk of outliving assets.
1. Transferring Inflation Risk
Because Social Security benefits have cost-of-living adjustments, you transfer some of the risk that inflation will erode your ability to cover expenses.
2. Transferring the Risk of Outliving Assets
A lifetime stream of payments, from any source, relieves you of some of the risk that you will not be able to cover expenses in your later years because your assets have all been spent. If you have a work record that makes you eligible for Social Security benefits, you transfer some of that risk to the U.S. government even if you retire at 62.
Delaying benefits allows you to maximize the transfer of the risk of outliving assets. There are two strategies for delaying receipt of benefits: you can either work longer, or you can retire but use your own assets to cover expenses that you could have covered with early receipt of Social Security benefits.
Working Longer to Transfer Risks
If you expect that Social Security will provide a large fraction of your retirement income, then working longer is the only practical way to transfer to the government the risks of inflation and of outliving assets. As illustrated by the example above, each year of work adds substantially to your monthly income.
Spending Assets to Transfer Risks
If other sources of income will be much larger than Social Security, your expenses are probably also much larger than your Social Security benefits, and you won’t be able to transfer much of your risk by delaying benefits. You might still decide to delay benefits if you believe that a long life will result in higher wealth if your monthly benefits are larger.
To compare the wealth effects of starting benefits at age 62 or 66, we compute the cumulative values of the income streams received from Social Security beginning at those two ages. For either starting age, we measure the value of the future income by computing an equivalent lump sum that you would invest for a 6% return and then draw down to provide income equal to your Social Security benefits.
Starting at age 66 causes you to fall behind the early retiree during the four years when you are not receiving benefits but he is. When benefits begin at age 66, your higher monthly income allows you to gradually catch up to the early retiree. With the assumption of a 6% investment return you reach a level of wealth equal to that of the early retiree in 17 years at age 79. Assuming a lower investment return leads to a younger “crossover” age, while a higher return to leads to an older crossover age.
The amount by which you fall behind by starting benefits at 66 is about $63,500 and represents your total cost to buy a larger annuity (i.e., a stream of lifetime income) from the government. You incurred the cost by spending assets to cover expenses that Social Security benefits would have covered if you had retired at age 62. Delaying Social Security benefits is thus very similar to a decision to purchase an increase in your annuity payments from an insurance company. In effect, you “buy” bigger payments by using your own assets to cover expenses.
Conclusion
By delaying Social Security benefits you maximize your transfer of risks to the government regardless of your financial situation, but you might think about the transfer in different ways. If you have few assets, your cost to transfer risks is paid in the form of additional years of labor, and that labor allows you to improve your retirement income by a large percentage. If you have many assets, your cost to transfer risks is paid with part of those assets, but the percentage change in your retirement income is generally small. For any financial situation, you should carefully consider the idea of delaying Social Security benefits if your family history and current health suggests a high probability of living past age 80.
Figure caption:
These curves show the cumulative value of Social Security benefits for persons who apply at ages 62 (thinner curve) and 66 (thicker curve).
