Saturday, August 9, 2014

Deferral of Social Security Commencement is a Reasonably Good Strategy, But it May Not be All That it's Cracked Up to Be.

This post is a follow-up to my posts of April 28, 2014, April 4, 2014, December 8, 2013 and July 23, 2013 on the benefits of deferring commencement of Social Security benefits. 

It is difficult today to read advice from retirement experts without running across statements such as, "it is a huge mistake to commence your Social Security benefit prior to your Normal Retirement Age", "You can significantly enhance your retirement security by deferring commencement", and "for many retirees, the increases in retirement income from the delayed retirement credits may mean the difference between poverty and comfort."  Most of these articles also mention the fact that the Social Security benefit commencing at age 70 for an individual with a Social Security Normal Retirement Age of 66 is 76% higher than the benefit commencing at age 62.

As I have said in previous posts, deferring commencement of Social Security benefits is a reasonably good strategy, but if you want to achieve significant increases in your total retirement income, you probably are going to have to keep working and deferring not only the commencement of your Social Security benefit, but also your actual retirement.  Most articles don't mention that if all you do is defer commencement of the benefit and dip into your accumulated savings to "bridge" the period of deferral (assuming you have such savings), the expected increase in your total retirement income will not be as near as much as you might have expected. 

The motto of the Society of Actuaries is, "The work of science is to substitute facts for appearances and demonstrations for impressions."  So the purpose of this post is to crunch some numbers and substitute some demonstrations for impressions.  Before I dive into the numbers, I'll say up front that I have only considered benefits of commencement deferral to the individual and have not considered additional benefits that may inure to the individual's spouse as part of the deferral strategy.  Also, Social Security benefits are fully indexed to inflation and that feature may not be fully captured by looking at deterministic projections of future experience.  On the other hand, I've assumed that the Social Security program will remain unchanged in future years despite its problematic financial condition. 

The tables below compare total annual retirement income (Social Security + Structured Withdrawals from Savings) produced under various Social Security deferral strategies vs. commencing Social Security immediately.  The success of any Social Security deferral strategy vs. immediate commencement generally depends on investment return on accumulated savings, inflation and age at death of the individual.  So I'll examine different assumptions for these items. 

Table 1 looks at deferring Social Security benefits from age 62 to age 66 (the assumed Normal Retirement Age).  Table 2 looks at deferring Social Security benefits from age 66 to age 70 and Table 3 looks at deferring Social Security benefits from age 62 to age 70.

In Tables 1 and 3, the individual is assumed to retire at age 62.  For the commencement deferral strategy the individual is assumed to dip into accumulated savings so that total retirement income (from Social Security and withdrawals from savings) is expected to remain constant from year to year (in real dollars) over the payment period based on the indicated assumptions.    Amounts shown in each Table, therefore, represent the initial total retirement income which is expected to increase by inflation each year over the expected payment period.  These calculations are performed using the Social Security Bridge spreadsheet on this website.

In Table 1, the individual is assumed to have $100,000 of accumulated assets and a Social Security benefit payable at age 66 (before any cost-of-living-adjustment increases) of $1,000 per month.  At age 62, she can commence her benefit of $750 per month, or she can defer commencement until age 66 and receive $1,125 per month ($1,000 plus four years of CPI increases of 3% per year under the 3% inflation assumption scenarios).  If she chooses to defer, she needs to dip into her accumulated savings.  It isn't cheap to do this.  Under the 5% investment return / 3% inflation assumptions, the present value at age 62 of these "bridge payments" is $46,646.  She is effectively purchasing a much larger deferred annuity payable from Social Security (fully indexed to inflation) with these bridge payments. 

How much more annual retirement income will she receive by deferring commencement of Social Security from age 62 to age 66?  It depends.  Under assumption scenario #1 (5% investment return, 3% inflation and expected payments until age 95), she will have total income under the commencement deferral strategy of $14,163 (such income to increase by 3% per year until her death at age 95) vs. total retirement income assuming immediate commencement of $13,054 (also increasing by 3% per year). The difference of $1,109 per annum equates to about an 8.5% increase resulting from the commencement deferral strategy under these assumptions.   

The other numbers on Table 1 and the numbers in the other two figures make the same comparison but use different assumptions and different deferral periods.  It should be noted that for Table 3, the individual was assumed to have $125,000 in accumulated assets because $100,000 would have been insufficient to bridge the period of deferral. 

Bottom Line:  Deferring commencement of Social Security can increase total retirement income under most reasonable assumptions.  This strategy also adds inflation protection and can provide larger benefits to your spouse.  If you want to quit working and adopt the commencement deferral strategy, you have to be willing to dip into your accumulated savings to make it work.  The degree of success of the commencement deferral strategy will depend on the investment return you could have earned on the "bridge payments" you withdraw from your accumulated savings, the rate of future inflation and how long you live.  Under most reasonable assumption scenarios, you don't see the increases in total retirement income that you might have expected from reading articles on this subject by the retirement experts.  Nor do you see the magnitude of increases necessary to lift retirees out of poverty and into a life of comfort.  

Readers are encouraged to do their own modeling of the commencement deferral strategy by using the Social Security Bridge spreadsheet.

 (Table 1 - click to enlarge)

  (Table 2 - click to enlarge)

  (Table 3 - click to enlarge)