Determining when to apply for your Social Security benefits requires looking at many factors. You must take into consideration how long you plan to work, you and your spouse's health, the future amount of both partners' full retirement benefits, income taxes now and in the future -- the list goes on and on. These variables call for you to use your best judgment because they are subject to change; once you have made your decision on the variables above you are then faced with a difficult choice.
When dealing with a dilemma, I find it helpful to compare your choices to something similar. Perhaps you have done this when purchasing a home or car. For example, it would be expected to compare cars of a similar price along with the manufacturer's warranty before you choose which one to buy. So what can you compare delaying your benefits to? What asset provides an inflation-adjusted monthly income that you cannot outlive and you can pass to your spouse? There are not many investment vehicles that are similar, but one comes to mind: an inflation-adjusted joint life immediate annuity. As the very long name suggests, it pays an inflation-adjusted income for your life and goes to your spouse when you pass away (a close match to Social Security benefits).
I will explain in more detail -- Social Security benefits can be claimed at any time between the ages of 62 and 70. The mid-point is considered full retirement, which is 66 years old for anyone born prior to 1954. Since this is the group of people facing this choice currently, I will stick with this age group for my illustration. If you claim your benefits between the ages of 62 and 66 they are reduced by approximately 6 percent every year. If you wait longer to collect, there is an 8 percent increase in your benefits, plus a cost-of-living adjustment each year between the ages of 66 and 70.
Making the assessment
Let's look at the following example and see if we can make a comparison:
- There is a 66-year-old married woman with a $2,000 per month primary insurance amount (her full retirement benefit at age 66).
- Assuming a 2.8 percent cost-of-living increase and yearly 8 percent delayed claiming credits, her benefit would grow to $2,948 if she waits until age 70 to claim.
- The difference between her benefits at age 66 (these benefits would receive a cost-of-living increase every year) by the time she reaches 70 and her benefits if she waits until 70 is $714 ($2,948 - $2,234 = $714).
While waiting to receive a higher payment she must use other financial resources to pay the bills. The forgone benefit is the cost of the increased payment. The $714 monthly increase is the annuity she will receive for foregoing payments for four years. In this example, that amounts to approximately $100,107.
To find an annuity for this comparison I turned to ImmediateAnnuities.com. This is one of the few websites where the public can access an annuity quote without providing contact information. I hope you can appreciate why I was not enamored with the prospect of providing an insurance company with the equivalent of an invitation to call me. The website was referenced in several well-know publications so I felt comfortable using the information, but only as a reference point for comparison purposes. This is by no means an endorsement.
That is a surprisingly high difference, but it actually has an explanation. Steven A. Sass at the Center for Retirement Research at Boston College prepared a brief in May 2012 with similar findings, and it provided insight as to why this difference exists. The benefits calculated for Social Security are designed to be actuarially fair -- meaning there are no additional costs embedded in your Social Security benefits. An insurance company that sells annuities has the additional costs of marketing, sales commissions, general overhead, and regulatory oversight and compliance. In total, these costs make up a significant portion of the price paid for an annuity.
In summary, delaying your Social Security benefits can be a cost-effective way to provide a higher income stream later in life. Stay tuned to the blog for more information on Social Security benefits. If you have any questions or comments stemming from today's piece, please leave them below.