Monday, April 28, 2014

Deferring Commencement of Social Security Benefit is OK, Deferring Retirement is Better

There have been a number of articles recently touting the benefits of deferring commencement of one's Social Security benefit.  For example, in my post of December 8 of last year, I quoted the author of one such article who said, "Rather than annuitizing retirement wealth, participants can get a much better deal by spending down retirement assets and deferring Social Security."  This post will examine a hypothetical situation in an attempt to quantify how much more retirement income a person could have by deferring commencement of his Social Security benefits.

Let's look at a 65 year old male with accumulated savings of $800,000 in 2014.  His Social Security Normal Retirement Age is 66.  He is eligible for a Social Security benefit of $2,000 per month (plus an inflation adjustment) if he retires at age 65 and commences his Social Security benefit at age 66, or $1,867 per month (.9333 X $2,000) commencing immediately if he retires at age 65 and commences at age 65.  Assuming annual inflation increases of 3% per annum, retirement at age 65 and deferral of his Social Security benefit until age 70, he would receive a benefit of about $3,060 per month (1.32 X $2,000 plus 5 years of assumed 3% per annum inflation increases).

The table below shows total spendable income available to the individual from accumulated savings, Social Security and, in the third scenario from a life annuity developed by using the simple spending spreadsheets found in this website and the assumptions recommended for use with the spreadsheets.  Readers are reminded that the spreadsheets provided in this website are designed to provide level real dollar total spendable retirement income from year to year over the expected payout period.

(click to enlarge)

Under Scenario 1, the individual retires at age 65 and commences Social Security immediately.  He uses the actuarial approach in this website (Excluding Social Security 2.0 spreadsheet) to determine his annual withdrawals from accumulated savings.

Under Scenario 2, the individual retires at age 65 but defers commencement of his Social Security benefit until age 70.  He uses the Social Security Bridge spreadsheet to determine the extra withdrawals from his accumulated savings that will, when combined with deferred Social Security benefit, provide level real dollar spendable income from year to year.  In this instance, the present value at 5% interest of those extra "bridge" payments is $152,480.

Under Scenario 3, the individual retires at age 65 and commences Social Security immediately.  He takes $152,480 of his $800,000 retirement nest egg and buys a life annuity.   I used a purchase rate of $14.03 per each dollar of annual income obtained from to determine the immediate life annuity payable at age 65.

As the table shows, total retirement income is comparable for the first three scenarios with the deferral strategy (Scenario 2) being somewhat better than the immediate commencement and no annuity purchase strategy (Scenario 1) but only slightly better than using the same amount of money to purchase a life annuity (Scenario 3) at current annuity purchase rates.

But, if this person really wants to get a significant increase in retirement income, he needs to work another five years.  Scenario 4 assumes that he continues to work until age 70 and retires at that point.  His accumulated nest egg in 2014 is assumed to earn 5% per annum and he is assumed to contribute $10,000 each year and his employer is assumed to contribute $2,000 each year.  While his Social Security benefit should increase somewhat as a result of five additional years of earnings and tax payments, we have assumed it would remain the same.  Under these assumptions, his benefit at age 70 is at least 35% higher than the benefits payable at age 70 under the other strategies.

Take Away:  Deferring receipt of Social Security may be able to get you a little more retirement income (depending on assumptions employed and actual experience), but if you really want more retirement income, you need to defer both your retirement and Social Security benefit commencement date.  This strategy works for you in two ways--it should increase your accumulated retirement nest egg and it reduces the expected payout period.