Tuesday, December 17, 2013

Delaying Social Security Benefits Revisited

Roughly a year and a half ago, I wrote about my decision to delay the start of my Social Security benefits. http://blog.jamesmjackson.com/2012/07/delaying-start-of-social-security.html In that article I argued that for those of us fortunate enough not to have to live off Social Security payments, we should  concentrate more on our risk of outliving our money rather than on the risk of dying too early and not spending all we could have. In the intervening months between the first article and this one a lot has happened politically and in the financial markets that make some question whether my decision to delay payments is still valid.

I think it is.

Politically, we are another eighteen months closer to running out of money in the Social Security Trust Fund with no hope of Congress acting in a manner to avert the problem. Many Republicans are back to ballyhooing their flawed idea of individual retirement accounts replacing traditional Social Security benefits (after all, the stock markets are hitting new highs) and Democrats are on this issue the “party of no”—as in they want no change, regardless of expert testimony that the current approach is unsustainable.

As each day passes, more Baby Boomers hit retirement age, making it harder to change their benefits. As a large demographic that votes, they can throw their weight around with targeted lobbying by organizations such as AARP. Given the demographics, it will take significant political will to make changes in Social Security. The 113th Congress has shown no political will or wisdom, and there is no reason to think the 114th will be better.

Congressional inaction continues to increase the risk of the Social Security Trust Fund running out of money. So with all that, why shouldn’t you do the Boomer thing of take the money and run.

Without Congressional action, the Social Security actuaries project the retirement Trust Fund will be empty around 2033. That does not mean Social Security benefits must stop. However, it does mean the benefits will become strictly pay-as-you-go: total payments (the benefit checks) can’t be more than the total income (the retirement portion of FICA taxes).

As I illustrated in the earlier blog, by deferring the start of Social Security payments until normal retirement age (66 for me, 67 for those born after 1959 and something in between for those born in 1955-1959) you maximize the portion of your assets indexed to inflation. Let’s say your Social Security normal retirement benefit starting at age 66 is $1,000 a month. If you begin payments at age 62, you will receive only $750 a month. Assume inflation runs at 3% every year (that won’t happen, but it could average out to about that). Here’s what you would get at various ages:

With Age 62 Retirement
With Age 66 Retirement

With Age 62 Retirement
With Age 66 Retirement






During the first four years you are unambiguously better off if you start your Social Security benefits at age 62. Over those four years you will receive around $37,500 in benefits. Assuming a risk-free return equal to the inflation rate, those payments would have an accumulated value of approximately $39,000. You’ll need that money to reimburse yourself for the greater normal retirement benefits you could have been receiving had you delayed your Social Security retirement. Your accumulated pot of money (continuing to grow with interest but shrinking with the make-up payouts) runs out around age 77. From then on you are less well-off compared to deferring Social Security retirement.

Because the Trust Fund will not run out of money until 2033, anyone born before 1956 who delays payments will have already reached their break-even point and thus be ahead of the game before the Trust Fund hits zero. Once the Trust Fund runs dry, and if there is no other change in Social Security, benefits must be cut by roughly 25% to balance benefit payments with FICA taxes. Note that if you delayed the start of benefits, you will continue to receive considerably more from Social Security each month compared to what you would get if you started benefits as early as possible because the cuts are proportional. Using Age 85 from the table above, if you took your benefits early a 25% cut reduces your monthly benefit from $1,480 to $1,110. The benefit those who deferred receive declines from $1,941 to $1,456.

Does that mean you can best hedge all political risk by deferring the start of Social Security retirement? Not necessarily. The scenario above assumes an across-the-board 25% haircut. While that’s what people are currently discussing, it is possible that the cuts could come from the top down by imposing a cap on the monthly benefit. Even in this take-from-the-rich-and-give-to-the-poor scenario, those my age are still better off delaying the start of retirement because the cut occurs after we have reached our break-even point. Younger folks will need to evaluate when it’s time for them to make the take early/defer decision. Also, Congress could enact this type of benefit cut earlier. It’s not likely, but it is possible, and if they did, it could delay the breakeven date, making it less attractive.

From my perspective at the end of 2013, the politics of the last year and a half have not changed my decision to continue to delay the start of my Social Security retirement benefits.

Recently someone smirked that if I had only taken early Social Security and invested those payments (after-tax) in the stock market, I would be monetarily far ahead. Investment gains would defer the break-even point—maybe even to eternity.

There are two problems with this argument. First, it uses an ex post facto analysis. When I made the decision to defer I did not know what the stock market would do. This looking at what actually happened and saying what I should have done is similar to saying that in December 2002, I should have sold my house, borrowed to the hilt, and invested it all in Apple at $14 bucks a share. Then, in perfect market timing, I should have sold the stock on December 17, 2012 at $700. [And even sold it short that day if I were so prescient.]

Social Security provides an almost risk-free investment. (It used to be risk-free until some Tea Party advocates decided having the US government default on its debt was acceptable.) Since my reason for delaying Social Security benefits is to insure against running out of money if I live too long, I should not then foul the comparison of a risk-free return and one investing early payments in a risky proposition such as equities. Doing so defeats the strategy of taking out longevity insurance. This faulty thinking is the same that caused many defined pension benefit plans to invest heavily in equities to “hedge” against morality risk. While stock markets rose, it looked brilliant, but in the recent past it proved disastrous for companies and governments alike. Some plan sponsors have frozen future benefits, and eliminated non-guaranteed benefits—not an option for an individual.

So unless I learn that I am suffering from a disease that significantly decreases my life expectancy, I plan to stick with my decision and defer the start of my Social Security benefits until I turn 70.

~ Jim

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