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Personal finance

A little waiting can lead to a big payoff from Social Security

An annuity, so to speak, from Social Security is a far better deal.
An annuity, so to speak, from Social Security is a far better deal.(istockphoto.com)

If an insurance salesman offered a product with a guaranteed income of nearly 7 percent for life, it would be foolish not to question whether it was too good to be true.

But the fact is, such a product exists. And it’s “on sale” right now, for many people 62 and older, at the Social Security Administration.

Some people nearing or on the cusp of retirement consider buying immediate annuities from insurance companies: They hand over a big pile of cash to an insurance company in exchange for a guaranteed monthly income payment for life. But you can also “buy” an annuity, so to speak, from Social Security, and it’s a far better deal.

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Think about it this way. If you delay collecting your benefits, which can be claimed anywhere from age 62 to 70, the money you leave on the table each year is basically a payment for a much higher stream of lifetime income. And that money will buy significantly more income, perhaps 50 percent more for a couple, than buying an annuity through a commercial insurer.

“It’s almost a no-brainer,” said Steven A. Sass, program director of the Financial Security Project at the Center for Retirement Research at Boston College, who analyzed the numbers. “Depending on how long you delay, you will get an income equal to about 6 percent or more of the savings used to produce that income. You will get that income, rising with inflation, with no risk, sent to you by the US government.”

Delaying benefits requires leaving sizable sums of money on the table, which, for many 60-somethings, could be too difficult — psychologically or financially. Some want to start collecting what they’re owed, while others simply need the money to live on. And individuals who aren’t healthy should clearly start collecting benefits as soon as they’re eligible.

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But for people who are yearning for more sources of guaranteed income, this strategy — buying more income from Social Security — is especially attractive now when interest rates are low. Commercial insurers cannot compete on price, specialists said, and they also have overhead the federal agency does not.

Consider a couple with a 65-year-old husband and a 62-year-old wife who decide to buy an immediate annuity — one where payments would keep pace with inflation, and that would continue to pay out as long as either spouse was alive. If they paid $100,000 to an insurer, they would receive in exchange guaranteed lifetime income of about $3,840 per year, according to a quote from Vanguard. That translates into a guaranteed income stream of 3.8 percent a year on the money they used to buy the annuity.

Next, consider what sort of income stream they could “buy” from Social Security by waiting to collect benefits. Assume the husband, who is eligible to collect $12,000 at age 65, delays claiming until he is 66. By waiting the extra year, he would get a benefit increase of $860, for a total of $12,860.

But if he had to buy that extra $860 annual income, he would have to pay about $22,500 to an insurer. A much cheaper way of getting the extra income would be to wait an extra year for his benefits, and dip into his savings for the $12,860 he is not collecting from Social Security. (Or he could potentially work an extra year and not dip into his savings.)

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By doing this, he receives a guaranteed income of 6.7 percent when he “buys” the income from Social Security, according to Sass’ calculations, compared with an income of 3.8 percent he would receive from an insurer.

“You will not get anything close to that anywhere else,” Sass added.

Now let’s imagine the retiree could afford to wait until he was 70 to collect benefits. By waiting those five extra years, his annual benefit would increase to $17,000.

But if he had gone to an insurer to purchase that extra $5,000 in annual income, it would cost more than $130,000, according to Sass’ calculations. The less expensive route would be to delay benefits, leave the $60,000 on the table, and also eat into his savings. That means he would be getting a 5.9 percent income if he “bought” the income from Social Security versus the 3.8 percent he would receive from an insurer.

These income rates also compare rather favorably to the income you can generate by a diversified portfolio of stocks and bonds. “Given the volatility of such a portfolio, there is a lot of debate and ongoing research about how much you can safely withdraw without outliving your savings,” Sass said.

Some research has found that the conventional wisdom — taking out 4 percent annually — could be too high. But for argument’s sake, let’s say it’s somewhere between 3 and 4 percent of the portfolio, and rises each year with inflation. That means you could initially pull out somewhere between $3,000 and $4,000 for every $100,00 invested.

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Delaying Social Security is a bit more attractive for married couples because you’re also getting something free that you would have to pay for in the commercial market: the survivor’s benefit. If the higher-earning spouse dies first, the survivor will continue to receive that benefit for the rest of his or her life. How much does it cost if you had to buy it? If we revisit the couple with a 65-year-old husband and 62-year-old wife, a survivor benefit for the wife reduces benefits by nearly a third, according to annuity pricing quotes from Vanguard.

“If you have a traditional couple where one worked a great deal and another didn’t work, by delaying claiming you can improve the survivor benefit substantially,” said Olivia S. Mitchell, an economics and public policy professor at the Wharton School of the University of Pennsylvania. “If you care about your wife or husband, that might also help them in old age.”

The benefits rise so that you will receive the same amount over your lifetime, regardless of when you begin collecting, if you live to average life expectancy. But if you are reasonably healthy, the payoff can be substantial. If the higher earner — or any worker — can hold off until they turn 70, the benefits collected will be at least 76 percent more than if payments started at 62.

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“There is this enormous payoff to waiting,” said Alicia Munnell, director of the Center for Retirement Research at BC. “And nobody knows that.”

Well, some people do. Of the 1.4 million men and nearly 1.3 million women who began collecting benefits in 2012, about 1 percent of the men and nearly 2 percent of women were at least 70.