Deferred Social Security likely to be
better than an annuity.
Henry K. (Bud) Hebeler
3/29/07
There are a lot of baby boomers that are going to ask if they can retire at 62 as well as whether their best alternative is to start Social Security at 62, their full retirement age (FRA), or 70. (The FRA is between 65 and 67 depending on their birth year.) A related question is whether they should start Social Security at 62 even if they will work part time. For all income over $12,960 (2007dollars), they will lose $1 of Social Security for every $2 of earnings until the year of their FRA, and then $1 of Social Security for every $3 earned in the months until they reach their FRA. The latter penalty only applies to earnings above $34,440 (2007 dollars).
Of course if you have health problems or lost your job and are unable to find work and don’t have enough savings for support until your FRA, you may have no other choice but to start Social Security at 62. Moreover, you might select an age 62 start if you are single and expect to die before age 80 or if you are married and expect both you and your spouse to die before 80. Some analysts suggest that you might benefit from an early start even if you expect to live past 80, but this requires returns far larger than retirees are likely to get from conventional retirement investments.
Let’s first consider a single person (or a person in a marriage with virtually the same Social Security benefits as the spouse). We’ll compare two people in this example, but you can make a parallel analysis for your own numbers.
Person A takes SS at 62 of $1,200 per month.
Person B takes SS at 66 of $1,600 per month.
If person B has $76,800, he/she can maintain $1,600 per month for the 48 months until starting SS. That's if B invests to equal inflation. (If B can invest to get 3% above inflation, he/she needs only $72,500.)
Suppose A also wants $1,600 per year. He/she needs an inflation protected immediate annuity that will provide another $400 per month. The least cost is for a single male. $88,100* will buy him $400 per month with an inflation adjustment. (An annuity for a female would be $97,025*. The cost of annuities vary depending on sex, current interest rates and costs of the insurer.) Since $88,100 is $11,300 more than $76,800, it’s better to use existing savings for 48 months than to buy the immediate annuity. Further, annuities may have lots of fine print exceptions and are more subject to complete default than Social Security which is tax based.
If A and B married and their spouses have Social Security benefits close to theirs, then couple A’s cost will be higher than B’s by 2 x $11,300, or 22,600.
The really big differences come if one spouse will be entitled to much larger Social Security payments than the other. That’s because a low-income spouse is entitled to part of the higher-income spouse’s benefits. If the low-income spouse waits till her/his FRA, the low income spouse will get 50% of the higher-income spouse’s benefits. However, if the low-income spouse also takes Social Security at 62, then she/he is entitles to something less than 37.5% of the higher-income spouse’s benefit. (The percentage is lower for those with higher FRAs.)
The other factor is that low-earnings spouses are entitled to 100% of their deceased partner’s benefits. This makes the comparison somewhat more difficult because if A & B die first, their spouses are entitled to $1,200 and $1,600, respectively (using inflation-adjusted values).
Knowing that, let’s continue the illustration assuming A and B and their spouses are the same age. Couple A, with age 62 starts, will get $1,200 + $450 = $1,650 per month. Couple B, with age 66 starts, will get $1,600 + $800 = $2,400 per month. Couple B will have to use $115,200 savings ($2,400 x 48 months) for the support until Social Security kicks in. Couple A will have to buy annuities that produce $750 per month ($2,400 - $1,650).
In order to approximately match the death benefits, A will
have to buy a lifetime annuity yielding $375 per month, and A’s spouse will
have to do the same. The cost of these
would be about $82,600* for the male and $91,000* for the female for a total of
$173,600. This is far higher than couple
B’s cost of $115,200.
You can do a similar analysis for your own Social Security benefit comparisons by getting inflation-adjusted immediate annuity quotes from the Web and using your annual report from the Social Security Administration comparing your benefits at 62, your FRA, and 70. Alternatively, there are both simple and comprehensive free Social Security programs on www.analyzenow.com that make the comparisons without quotes.
For most couples where at least one of the parties would expect to live into the eighties, the best solution is for the higher income spouse to wait until age 70 to start Social Security and the lower income spouse to start at the FRA. The fly in the ointment may be the amount of savings that are needed to delay Social Security payments that long. You wouldn’t want to wipe out all of your savings to get to a result that is better in theory but have no practical way to cope with emergencies and unknowns that take significant cash from savings.
Social Security will suffer some in future years, but the most likely things would not significantly affect the Social Security decisions from an analysis of this kind. The major alternatives are likely to be some combination of a gradual increase to the FRA, additional SSA taxes, and increasing the initial Social Security benefit by the CPI rather than a wage index. If there is a large difference in the costs between A and B now, it’s likely that there will still be a large difference in the future as well.
* Vanguard.com quotes as of March, 2007.