Andy became my client after he retired but before he turned 62. He is one of the fortunate few these days who have both Social Security and a pension. Not only that but, in the words of Thomas Stanley, author of “The Millionaire Next Door,” Andy was a prodigious accumulator of wealth. He is the type who never made a huge salary but consistently spent less than he made, accumulating savings that he will never need. You see, his spending in retirement is not projected to exceed his guaranteed income sources until age 93.
Retiring early was a good idea for Andy. Unfortunately, he also received some bad advice.
First, someone recommended that he use the level income option for his pension so he could retire at age 55 with an income source. He’d be frontloading his pension — getting most of its benefits in the early years instead of receiving equal installments over this lifetime. The plan was to have his pension drop to a pittance when he reached 62 and could claim Social Security. The other bad advice he received was to start claiming Social Security at age 62.
In Andy’s case, just one seventh of the pension benefits of his early years will be available to protect him should he live beyond average life expectancy. Not very significant longevity insurance. Fortunately, he’s not likely to run out of money because his savings are greater than what he’s expected to spend during retirement. But should he live past average life expectancy, say to age 95, he will receive a lot less money from his pension than he would have if he took the standard pension option.
Pension payments are based on an average life expectancy so living even a month longer provides more benefits. At the same time, real longevity protection begins when the client lives beyond the planning horizon, which differs by advisor. Your savings are designed to account for inflation and planned events. If you live longer than the planning horizon, there is a chance you will have no savings to offset those variables.
Every client wants to die having exhausted his/her retirement resources. (If you want to leave a legacy to children or charities, in this context, those are not retirement resources.) Unfortunately, we do not know when our clients will die so it is difficult to plan for their savings to be zero at the hour of their death. But, since that is what we are planning for, a significant risk is that the client lives longer than the planning horizon. Social Security and other payments that will last as long as the client lives provide “longevity insurance” that they cannot outlive.
The very best feature of both Social Security and pensions is the longevity insurance. The plans will pay you until you die, whether that’s at age 76, 96 or 116.
There are situations where front-loading a pension might make sense, such as when an individual has shorter than average life expectancy or if the individual has no other resources to bridge to a superior resource. In this case, there were plenty of other resources to fund a delay to Social Security.
Why Delayed Claiming Works for So Many People
We reviewed Andy’s situation when he was 61, and he decided against filing for Social Security at age 62, as his former advisor recommended. Even with his reduced pension payout, it made sense for him to postpone claiming. Spending money from his savings still left him enough to generate the income he needs over the longer term. By waiting, he’ll lock in gains on his Social Security payments.
Like other advisors, I admit that I cannot guarantee my clients’ IRAs will beat the 8% growth that Social Security will pay between full retirement age (in Andy’s case, 66 years and 10 months) and age 70.
However, if my client retires prior to age 70 and withdraws from an IRA to fund those years, I know those dollars are not available for investment between age 70 and whenever the plan ends (which is age 95 or 100 for the plans I design). I can earn my client something for those 25 to 30 years and, cumulatively, it may exceed the 8% the client will get from Social Security for three or four years. I test this in my plan analysis.
Most people will benefit from waiting to collect Social Security. The breakeven point for delay varies between age 76 and age 81. According to the Social Security Administration, life expectancy at birth is 76 years for males and 80 years for females. However, you do not claim Social Security until you are in your sixties. By age 66, after surviving the diseases that kill children and young adults, life expectancy climbs to 83 for males and 86 for females.
The average life expectancy of the population receiving Social Security is five years older than the breakeven point. More than half of Social Security retirement recipients should live longer than their life expectancy at birth and many of them should benefit from delaying Social Security.
Alicia Munnell and Anqi Chen, from the Center for Retirement Research at Boston College, have found that, generally, waiting is better. Their “analysis shows that the reduction for early claiming is too large, while the delayed retirement credit – initially too small – is now about right.” They also discuss studies that found more wealth leads to longer life.
While million-dollar investment portfolios are not a requirement for working with most financial advisors, it is fair to say that the average client of financial advisors is wealthier than the average American. Considering that more than half of Social Security retirement recipients should live past breakeven and research connects wealth and longevity, those working with a financial advisor should have even better odds of living past breakeven.
What About Your Client?
To optimize your client’s wealth when claiming Social Security, start with your retirement projection as calculated in your financial planning software. Keeping everything else constant, adjust the Social Security start date. First look at the difference results at age 62, the client’s full retirement age and 70. Normally, the legacy wealth at the end of the plan is greater as you increase these figures. If that is the case, try changing the Social Security start date to each of the years from full retirement age to age 70.
Terminal wealth may be larger every year or there may be a sweet spot in an interim year. You may also find that the change in value, between say 69 and 70, is not so significant that it warrants waiting.
In Andy’s case, my firm’s proprietary software calculated terminal wealth increases every year but the gains in the first two years are much larger than the last two. Over his lifetime, he’ll gain $32,000 by waiting from full retirement age (66 years, 10 months) to age 67 and another $32,000 waiting from age 67 to age 68. The increase was only $16,500 between age 68 and 69 and only $2,000 between age 69 and 70. We agreed he should start collecting Social Security at age 68 because the increases between 62 and 68 added sufficient value while those last two increases until 70 did not.
A Rare but Possible Phenomenon
The Social Security claiming date is independent of a client’s retirement date. That means that Andy, retiring at age 55, should have been spending his retirement savings while waiting for Social Security to start. By considering a client’s total resources, there have been situations, although rare, where I have found that preserving savings by claiming early provides more terminal wealth.
In general, though, my hypothesis is that we are spending money between 62 and 70 from savings when claiming Social Security later. Those dollars, coming out of a finite pool of resources (the client’s savings) are spent and may not be available to generate earnings from age 70 until the end of the plan. For some clients, losing those earnings is enough to put the plan at risk. Even though the client is getting more out of Social Security by delaying, the client may be getting fewer resources from their savings by spending it earlier.
People often talk about increases of hundreds of thousands of dollars from waiting to claim Social Security. They are usually comparing claiming at age 62 compared with age 70. Andy would gain $270,000 between age 62 and age 70. He would gain $82,000 between full retirement age and age 70.
Sleep Matters, Too
Numbers matter. Sleeping at night also matters. For some clients, an earlier claiming age may be appropriate. Math does not always overcome a gut feeling. Some people are concerned they will have a shorter-than-average life. Some ardently believe it is better to spend money from the government than to spend their savings, unconvinced they will get more government money later. It is not always easy to convince clients who don’t trust the government that they may be putting their retirement at more risk by collecting Social Security earlier.
Social Security presents many variables that should be considered. For instance, couples are more complicated to analyze than single people. Generally, the higher-earning spouse should delay the longest but sometimes both spouses may want to delay until age 70 or a few years earlier.
A few items that might require addition analysis include:
- Life expectancy of the retiree or the couple.
- Willingness and ability to work additional years.
- Resources to provide income until Social Security is claimed.
- Benefits that might be available as a divorced spouse or as a widow(er).
- Benefits for dependents based on the retiree’s work record.
- Impact if neither spouse lives to the end of the plan.
- Impact of spouses with different ages.
Except where clients have had health issues, I have only run a couple of scenarios where the best outcome comes from claiming before full retirement age. My hypothesis is that this happens when the retiree has a limited margin of safety for a successful retirement.
While age 70 is the best claiming age for most clients, it is not uncommon to recommend a claiming age between 67 and 69. If the lower-earning spouse will receive less than half of the higher earning spouse’s full retirement age benefit, they generally should claim at their full retirement age. This is because the spousal benefit does not increase after they reach full retirement age. If they will get more than half, it may make sense for the lower earner to wait and collect on their own record at age 70.
When you complete a retirement plan and analyze different Social Security claiming options, you can provide the client with a clearer picture of the benefits. An analysis restricted to the Social Security cash flow does not account for many of the other variables in the client’s situation.
Given that few retirees choose to wait to claim their benefits, having a more nuanced proposal might help you convince the client to wait. When the differential for waiting a year is small, the certainty of claiming in the earlier year has merit. The client can decide if it is worth delaying for a year when the payoff is $5,000 or $15,000 or $25,000. Providing this information gives the client agency and the data they need to decide; otherwise, they will decide based on their gut.
This decision is an important one for your client. You provide a valuable service if you can give them more confidence in the outcome.
John Comer, CFP®, is a financial advisor with Twin Cities-based McNellis & Asato, Ltd., which offers financial planning through Raymond James Financial Services Inc. and investment advisory services through Raymond James Financial Services Advisors, Inc. He is a coauthor of the forthcoming book “Joining the Longevity Revolution: For Advisors and Clients,” which is expected to be in print later this year. He can be reached at 952-548-3134. Any opinions are those of John and not necessarily those of Raymond James or McNellis & Asato.