In part one of this series on Social Security benefits (“Your Social Security Benefit Strategy”) I said that your Social Security benefit is the bedrock of your retirement income floor, and that by deferring claiming your benefit you can add substantially to your benefit amount—up to 75% by delaying until age 70.
Let’s look closely at how this works so you can understand how your SS claiming strategy will impact your retirement income plan.
The couple I am using as an example here has an important goal. They know they need a larger low-risk retirement income floor to cover their essential expenses. Their Social Security benefit, whatever age they claim, will not be enough. So regardless of when they claim Social Security, they are going to need to use some of their savings to buy additional secure retirement income.
This analysis will help them understand the cost of that additional retirement income by comparing the cost of deferring their SS benefit with the purchase of an offsetting low-cost immediate income annuity.
There are other secure flooring approaches, such as buying a ladder of Treasury bond STRIPS, but for simplicity, we’ll use low-cost annuities here. The SS claiming logic and the logic of the comparison is the same regardless of the alternative retirement income option. Cost for cost, which is the better deal for you?
Section One – The Annual Difference in Social Security Benefits
Section one in the spreadsheet shown below is a simple cash flow that shows the differences in benefits through age 70 for claiming at different ages, and a cumulative total for a selected claiming age. (You can download this spreadsheet here filled in with the example data or blank, ready to modify for your own use—instructions for using it are further below).
For simplicity, the annual benefit is shown as constant from the age claimed, though your actual benefit amount increases each year based on the CPI (inflation). The inflation adjustment is an important part of your SS benefit, but it’s not critical to this specific analysis. Let’s take a look at the sample data.
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The example shows a couple, two years apart in age, planning to stop working (shaded “Retirement Year” rows 14 and 15) at ages 65 and 64. Their ages are shown in column one for each and their full retirement benefits are shown at age 66 in the second column for each, discounted to age 62 for early claims, and increased to age 70 for delay credits.
The third column for each shows their benefit in the claiming year, carried forward to age 70, when the ability to increase the benefit with delay credits ends.
The totals on line 24 show that spouse one would collect $162,000 and spouse two, with a lower benefit but starting a year earlier, would collect $169,050, and together as a household, they would collect $331,050 for the period through age 70.
If they both defer to age 70 to max their benefits, that $331,050 is the amount they would have to use from savings (or continuing employment or both) to make up for the deferred benefits.
The green box on lines 29-31 shows that their combined maximum annual benefit (deferred to age 70) would be $74,448 while their combined annual benefit if claimed earlier in their planned retirement year would be $51,150, a $23,298 annual difference.
Section Two – Making Up The Difference
Section two shows how much it costs to replace that $23,298 annual difference if the couple claim early, compared to using savings to offset their deferred SS benefits and claiming their maximum benefits at age 70. This section is automatically calculated from the spousal benefit amounts entered in section one.
This section is based on recent quotes from the Vanguard website, which offers low-cost single-premium immediate annuity (SIPAs) quotes from a number of highly rated insurance companies through an arrangement with Hueler Investment Services. These low-cost annuities bear roughly the same relationship to more controversial and risky high-cost variable annuities that term insurance has to costly variable life insurance. SIPA’s are a low-cost, low-risk way to add to your secure retirement income floor. I’ll discuss this and other factors further in part three of this series.
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Line 39 shows the annual difference for each spouse between their SS benefit amount at retirement date and their maximum SS benefit if they deferred to age 70.
The ‘effective’ rate shown on line 43 is calculated from the average of several current quotes from Vanguard/Hueler for annuities for age 70 males and females (the older you are when you buy an annuity, the higher the ‘effective’ rate, since your life expectancy is shorter). These are single-life annuities, no survivor benefits, but with an annual 2% increase, providing limited hedging against inflation, and purchased at age 70 when the deferred maximum SS benefit would have kicked in if the couple had not claimed early.
Line 45 shows the cost of an annuity for each spouse to replace the annual income difference shown on lines 27 and 39 at the ‘effective’ rate shown on line 43.
The bottom line is easy to see—for this couple, maxing their SS benefits has an ‘effective’ rate of 7.04%, compared to a combined ‘effective’ rate of 5.83% for the two annuities.
In simple terms, the annuity costs the couple $68,862 more from their savings than funding the deferral period from their savings to gain an equal but fully inflation-indexed SS benefit.
The specific amounts and rates will vary for each individual or couple based on SS benefits expected at FRA and planned retirement/claiming dates. Note also that interest rates change over time, and the actual cost of an annuity when the couple reach age 70, years from now, is unknown—I’ll discuss this more in part three.
Hopefully, you see that your SS benefit strategy should be more carefully considered than just claiming as soon as you can. It may cost you a lot of money to not fully explore how best to manage your SS benefit within the context of your whole household retirement income needs.
We’re not done yet! There are other risks and considerations besides this cost analysis that impact your SS claiming strategy and your retirement income plan that might change your approach. In part three, we’ll review some of these other factors.
Instructions for using the Social Security Deferral Spreadsheet
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- Download the spreadsheet here
- Get you and your spouse’s, if you have one, estimated monthly benefits at full retirement age (FRA) here on the SSA website
- Copy and paste the three columns from line 11 to line 19 for each spouse so your ages line up (you don’t have to do this, but gives you a better year-by-year sense of cash flow)
- Plug in you and your spouse’s full retirement monthly benefits from the SSA estimator into the boxes for “FRA monthly benefit” on line 5, replacing the $1,000 placeholders
- The spreadsheet will populate your annual benefits from age 62 to 70, with your full retirement annual benefit shown at age 66 (the SSA calculator also shows the amounts for age 62 and 70, which may vary slightly—and which is not critical to the overall analysis)
- Pick the retirement/claiming year for each spouse, and enter the benefit amount for that year in the cell alongside that year under “Claimed Benefit” in column three for each (you can move the shaded label in column one to line up with your claiming year to make the spreadsheet look pretty but you don’t have to)
- The spreadsheet will fill out the subsequent years in column three with that benefit amount, total everything up, and do the annuity calculations in section two; it’s simple math, nothing to be afraid of—one of the virtues of cash flow analysis!
- You can vary the claiming dates to try different scenarios, perhaps varying how long you will use employment earnings or savings to defer claiming and lowering the cost of any annuity needed to make up the difference
Keep in mind you may need to buy additional secure retirement income flooring beyond this SS benefit analysis in the form of annuities, Treasury or corporate bond ladders, or other safe investments. This spreadsheet is intended only to show the relative cost of deferring SS benefits compared to a low-cost annuity that gives you the same retirement income after age 70 for some part of your retirement income floor. How much flooring you need overall is the subject of the series of posts here on Lifetime Financial Planning and retirement income management (see “What Is Retirement Income Planning”).