Despite all the talk about the value of maximizing Social Security benefits, it seems few retirees are listening. The fact that only 4% of retirees wait until age 70 to claim their maximum retirement benefits is not news. What is noteworthy, however, is how much those early claiming decisions are costing retirees in terms of potential retirement income and overall wealth.
Social Security pays over $1 trillion in benefits to more than 65 million people each year, or about nine out of every 10 retirees. It accounts for about one-third of all retirement income each year. About 50% of current retirees report that more than half of their annual income from Social Security while a third report than more than 90% of their income comes from these benefits.
A new study, "The Retirement Solution Hiding in Plain Sight: How Much Retirees Would Gain by Improving Social Security Decisions," quantifies the lifelong impact of workers claiming benefits before their full retirement age. The study was co-authored by Matt Fellowes, head of retirement-focused robo-adviser United Income, and two former top researchers at the Social Security Administration.
U.S. retirees would be able to generate an additional $3.4 trillion in income during their retirement — an average of about $111,000 per household — if they optimized their decision about when to claim Social Security, the study calculated. Nearly all of this income is lost because one or more retirees in a household claimed Social Security too early, which means their Social Security benefit is lower than it would be if they had waited.
Spread out across the population of individuals who are claiming Social Security suboptimally, those extra dollars add up to a substantial amount of money and could significantly improve retirement outcomes for a majority of Americans.
"About 92% of retirees that claimed Social Security suboptimally would have seen their annual income increase if they had made the claiming decision that maximized the probability they would have enough money to afford retirement," the study found. More than half of those retirees would see their annual income in retirement increase by more than 25% in their 70s and 80s.
Bottom line: About 21% of those at risk of not being able to afford retirement would see an improvement in their chances if they claimed Social Security at the optimal time, the study found.
For some people, the best way to delay claiming Social Security is to work longer. Wealthier retirees can afford to draw down their savings while waiting until age 70 to claim maximum Social Security benefits.
Deciding when to claim Social Security benefits also has an enormous impact on end-of-life wealth.
While it is true that most retirees will lose wealth in their 60s and their early 70s if they choose to delay collecting Social Security, they will be wealthier in their late 70s through the rest of their lives because of the effect of drawing down more investments in their earlier years of retirement and less in later years as higher Social Security benefits kick in.
Current retirees will collectively lose an estimated $2.1 trillion in wealth because they made the suboptimal decision about when to claim Social Security, or an average of about $68,000 per household.
Part of the problem is that it is too easy to claim Social Security benefits early at age 62. And recipients often aren't aware that their benefits will be reduced by 25% or more for the rest of their lives.
The authors made a bold suggestion that public policy should be changed to nudge people toward more appropriate claiming decisions.
"We believe early claiming should be made an exception and reserved for those who have a demonstrable need to claim benefits before the full retirement age," the study concluded.
Jason Fichtner, one of the study authors and former chief economist at the Social Security Administration, admitted that there is virtually no political appetite for that type of policy change.
However, he said the same goal could be accomplished by changing how the Social Security Administration describes claiming ages to the public. Instead of portraying age 62 as the "early eligibility age," it could simple be labeled the "minimum benefit age," and age 70 could be labeled the "maximum benefit age."
The study authors also suggested that there is a clear disincentive for traditional wealth management firms, which manage over $20 trillion in retail assets, to help clients make optimal Social Security claiming decisions since such decisions are likely to result in investment account balances declining in the short run.
"Providing cover for executives at these firm to make the right financial decisions for their clients, and the right long-term decision for their shareholders, may be helpful at accelerating the adoption of highly efficacious Social Security advice," the authors concluded.
Check out Mary Beth Franklin's podcast, Retirement Repair Shop.