Deciding when and how to claim Social Security benefits is not just a simple matter of collecting smaller checks earlier or bigger checks later. Current and future economic conditions can have a big impact on the net present value of benefits over a retiree's lifetime.
A new white paper on optimizing Social Security produced by New York Life found that “for reasonable rates of return and inflation assumptions, delaying Social Security results in a higher present value dollar amount and considerably higher cumulative balance of Social Security payments than claiming Social Security early.”
The full retirement age is currently 66 for anyone born from 1943 through 1954. An individual is able to claim Social Security retirement benefits as early as 62, but they will be permanently reduced by 25% for the rest of the person's life compared with claiming full benefits -- known as the primary insurance amount -- at 66. Alternatively, delaying the start of benefits every year past 66 increases benefits by 8% per year up to age 70 for a maximum increase of 32%.
The higher Social Security benefit collected at 70 will result in higher annual cost-of-living adjustments. For married couples, maximizing the Social Security benefit of the higher-earning spouse also results in a larger survivor benefit for the remaining spouse.
The paper found that the lower the discount rate, defined as the rate of return on an investment minus any fees and taxes, the higher the benefit of delaying Social Security.
It also found that the higher the long-term inflation assumption, the higher the benefit of deferring Social Security, as annual cost-of-living adjustments are applied to a larger base benefit claimed at older ages. Finally, the longer the life expectancy, the higher the benefit of deferring Social Security.
For a conservative investor in today's low-inflation environment, which is likely to increase over time, it makes sense to defer Social Security benefits until they are worth more.
Consider an example from the white paper of a 62-year-old investor who is weighing the trade-offs of claiming Social Security at 62 versus 70. She has earned an average of $60,000 per year throughout her career. Her primary insurance amount at full retirement age is $2,460 per month.
Assuming a discount rate of 5%, a long-term inflation rate of 2% (which is the amount her Social Security income will grow each year) and an income tax rate of 28%, the benefit of delaying Social Security until 70 results in larger present value and cumulative benefits over her lifetime.
If she lives until she is 88, her cumulative benefits would be about $950,000 if she claimed benefits at 62, versus more than $1.1 million if she waited until 70 to claim. Thus, delaying claiming Social Security until 70 increases her lifetime benefits by 16%, or more than $155,000, and raises the present value of those benefits by more than $52,000, to nearly $410,000.
If she lives until 94 — which one-quarter of today's 62-year-old women are likely to do — delaying Social Security until 70 boosts her lifetime benefits by 25%, to more than $1.7 million, and increases the present value of her benefits by more than $100,000 to about $522,000.
Married couples have additional options for maximizing their Social Security benefits. They can use creative claiming strategies that allow one spouse to “file and suspend” at full retirement age, triggering spousal benefits for the mate, while allowing his or her own Social Security benefits to continue to grow to the maximum amount at 70.
In some cases, when one spouse has already claimed Social Security, the other, who must be at least full retirement age, can file a restricted claim for spousal benefits only and collect half of the first spouse's full retirement age amount while his or her own Social Security benefit continues to accrue delayed retirement credits up to 70.
(Questions about Social Security? Find the answers in my new e-book.)