The Head-Scratching Math Behind When to Claim Social Security Benefits

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Should I start collecting Social Security retirement benefits as early as possible, or hold off for longer in exchange for plus-size payments? There’s no time to waste. I’m only 14 years away from eligibility, and from what I’ve seen I’ll need at least that long to figure out the math.

Here are the basics: If you were born in 1960 or later, normal retirement age is 67, and the payments you can lock in then are called your primary insurance amount, or PIA. You can lock in smaller payments beginning as early as age 62, or larger ones as late as 70. The amounts are calculated to rise each month—by 5/12ths of 1% of the PIA between 62 and 63, by 5/9ths of 1% between ages 63 and 66, and by 2/3rds of 1% through age 70.

That’s it. There’s no team of data scientists factoring in the latest intelligence on longevity, or analysts making sure the reward for waiting reflects current interest rates. It’s just a bunch of fractions that were set in 1983, when I was in Little League, and today they fit about as well as my old uniform. That means I can beat the system if I choose wisely. And there’s plenty of incentive to get it right. For married couples with at least one high earner, the present value of future payments can easily top a million dollars.

The problem is, even people who study Social Security for a living can disagree on when to take benefits. To really nail the decision, I need to know what my future investment returns will look like, and when I’ll die. I’d ask my soothsayer, but we had a falling out over who’ll win the election.

If you’re approaching 62 now, here are some numbers that might help. A healthy male who delays benefits until 70 receives a real, compounded return of 3.2% a year, according to Wade Pfau, director of retirement research at McClean Asset Management. “Real” here means after inflation, because Social Security payments get cost-of-living adjustments. The calculation was done in 2015, which is recent enough for our purposes. For a healthy female, the return is 4% because females tend to live longer. For couples, it’s 5.2% because there are spousal benefits, so payments last the longer of the two lives.

Compare those returns with another investment that provides inflation-adjusted returns backed by the U.S. government, called Treasury inflation-protected securities, or TIPS. Bonds have gotten so wacky that a 10-year TIPS yields less than zero—about -1%.

That seems like a slam dunk. Social Security’s decades-old deal for waiting trounces anything available today with a similar guarantee and inflation protection. Pfau says that just about everyone should delay payments. There are obvious exceptions, including people who need the money and those with terminal illnesses. For couples with lopsided incomes, the low earner might want to take his or her benefit early, knowing that it will soon be replaced by spousal benefits on the high earner’s amount.

I also spoke this past week with Boston University professor Laurence Kotlikoff, who has a planning tool for subscribers, He says the deal for delaying is so good that new retirees should consider dipping into 401(k) and other retirement accounts to tide themselves over.

So what’s there to think about? For one thing, TIPS yields might not be the best comparison. The Social Security Administration itself published a study of the matter in 2016, titled “Discount Rate Specification and the Social Security Claiming Decision.” It’s based on people born in 1952, so it gets slightly different numbers than the aforementioned ones. More importantly, it argues that investors might want to compare the implied returns for waiting with the returns they’re likely to earn by collecting payments early and adding them to portfolios that include stocks.

According to the SSA report, claiming right away at age 62 is optimal for men who assume investment returns of 3.8% or higher after inflation, or women who assume 4.6% or higher. The report cites Ibbotson Associates data showing that large-company stocks have returned an average of 6.7% after inflation over the long haul, and small-company stocks, 8.8%. Of course, returns can vary wildly over shorter periods. Over the past five years, large-company stocks have returned much more than the average, and small-company ones, much less.

For the portfolio strategists I see touting their skills on Twitter, I haven’t yet asked Ibbotson what long-term return to assume for a standard 60/40 Robinhood mix of Tesla (ticker: TSLA) and Bitcoin.

If you’re approaching 62 now, I think the decision is straightforward. Stock valuations are high, which historically has tended to predict below-average returns over the following decade. Bond yields we can know in advance, and they’re terrible. The fact that you’re reading my columns in Barron’s suggests you might be rich enough to wait on collecting benefits. And the fact that you’re rich gives you a statistical edge on life expectancy. You should probably delay payments.

Claiming benefits late reduces longevity risk—the risk of outliving savings. But it presents the risk that you won’t maximize benefits if you die before your life expectancy. If that happens and you have life insurance, at least your heirs will get to pickpocket the actuarialists to make up for Social Security pickpocketing you.

I’ll probably delay, too, but I’ll factor in what stock and bond valuations look like come 2034, when I hit 62. Speaking of 2034, that’s precisely the year when the old-age portion of the Social Security Trust Fund is expected to run dry. After that, taxes will cover only 76% of benefits. There are sensible ways for Congress to fix that now. My guess is it will ignore these, then turn to a yearly process of midnight-hour wailing and preening to plug shortfalls, acting only because old people vote. But it’s just a guess, and even my soothsayer tells me that one’s too crazy to call.

Write to Jack Hough at Follow him on Twitter and subscribe to his Barron’s Streetwise podcast.

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