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Rethinking Social Security: The Case Against Delaying Benefits

Many financial advisers advocate postponing Social Security retirement benefits to maximize payouts. However, a significant number of individuals opt for lower benefits at an earlier age.

Mark Hulbert, a senior columnist for MarketWatch, aptly highlights this dilemma: “The puzzle is why so many retirees claim their Social Security benefits at earlier ages, even though the nearly universal advice from financial planners is to delay claiming as long as possible”.

The opinion is divided. While most people agree that delaying offers benefits, it may not always be the best option.

Understanding the Benefits Structure

The current full retirement age for Social Security benefits ranges between 66 and 67 years for individuals born between 1954 and 1960, with those born in 1960 or later having a full retirement age of 67.

Delaying benefits beyond the full retirement age increases initial benefits by 8 percent for each year delayed until age 70. Conversely, claiming before the full retirement age results in a reduction of benefits by 5/9 of 1 percent for each month taken early, for up to three years, followed by a reduction of 5/12 of 1 percent for up to two additional years.

For example, if we use $1,000 as a monthly base for a full retirement age of 67, Table 1 illustrates the impact of various starting ages.

Many financial experts, including Altig, Kotlikoff, and Ye, assert that “the vast majority of American workers should delay taking their retirement benefits until 70.” Similarly, Fried emphasizes the importance of having the highest earner in a household wait until age 70 to claim Social Security, arguing it is crucial for boosting retirement income.

Despite this advice, data reveals that, in December 2022, 64 percent of retired workers receiving Social Security benefits began before reaching their full retirement age. The most common initiation age was 62, with 27 percent of retirees choosing this option, while only 10 percent claimed benefits at age 70.

The Illusion of Guaranteed Returns

Some advisers mistakenly equate the 8 percent annual increase in benefits from delaying payments with a guaranteed rate of return.

Laurence Kotlikoff argues that the Social Security system offers a safer return than traditional investments, stating that delaying benefits yields “a guaranteed return of 8 percent per year”. However, this view overlooks critical realities.

Here’s an interesting video on the topic:

Assessing Implicit Rates of Return

Using a base of $1,000 in monthly benefits, we analyzed the present value of lifetime benefits starting at ages 62, 67, and 70, considering various life expectancies and a 3 percent discount rate. The benefits indexed for inflation should be discounted by a real required rate of return.

For individuals with life expectancies around 84 or 85, the three starting ages yield comparable present values. However, advice suggesting delaying benefits until 70 is primarily valid for individuals expecting to live well beyond average life expectancy.

Discount Rates and Their Impact

The decision to delay benefits is further complicated by the discount rate used. For instance, at discount rates exceeding the breakeven points, initiating benefits at age 62 becomes more financially advantageous than starting at age 67, and starting at age 67 is preferable to waiting until age 70. In fact, for many individuals, starting benefits earlier could yield higher lifetime benefits even when applying a 0 percent discount rate.

The Significance of Personal Circumstances

Financial advisers advocating for delayed benefits often operate under the assumption that individuals are not constrained by liquidity issues. However, many retirees face urgent financial needs, necessitating early claims. Additionally, the Social Security system is intricate, with different rules for spousal benefits, survivor benefits, and specific circumstances that can influence the decision to delay.

For those working before reaching full retirement age, earning above a set threshold incurs a penalty, which may further complicate the decision to claim benefits early.

Conclusion: Evaluating Timing Decisions

This analysis challenges the belief that the majority of individuals making early claims are erring in their judgment. For example, a 4 percent real return necessitates living to age 89 for it to be beneficial to delay starting benefits from age 67 to 70. However, approximately 77 percent of 67-year-old males and 65 percent of 67-year-old females do not live to age 89.

While there are non-financial factors influencing the decision to delay benefits, such as concerns about future legislative changes or personal spending habits, individuals should assess their unique circumstances. For those able to manage their finances prudently, claiming benefits before age 70—or even before full retirement age—could be a sound financial strategy that maximizes their overall benefits.

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