Friday, September 25, 2015

Another Look at Deferral of Commencement of Social Security Benefits

My retired neighbor, Leon, is turning age 62 in the near future.   A couple of days ago, when I was out performing what our dog believes is my primary purpose in life (being his personal bathroom attendant), Leon asked me for my thoughts about whether he should defer commencement of his Social Security benefit.   Like everyone else, he had read many articles from experts who strongly recommend that retirees defer commencement of their Social Security benefits.  Leon pointed me to Michael Kitces’ April 2, 2014 post where Michael said, “the decision to delay Social Security actually represents an astonishingly valuable ‘investment return’.”  Leon had also done his “breakeven” calculations. 

I told Leon that while deferring commencement of Social Security could be financially advantageous, I believed (and my prior posts on this subject have indicated) that deferral is not necessarily a “no-brainer.”  The effectiveness of the deferral strategy depends on a number of considerations, including:  1) how long you will live, 2) how much savings you will use to “bridge” the period of deferral, 3) what investment return you could earn on your savings and 4) the rate of future inflation. 

The table below shows the increase/(decrease) in the present value of a retiree’s spendable income associated with deferring a $750 per month Social Security benefit payable at age 62 until age 70 vs. commencing the benefit at age 62 assuming various ages of death.  The table uses the same assumptions and hypothetical retiree as used in Mr. Kitces’ article.  The calculations were performed using the Social Security Bridge spreadsheet from this website.  

(click to enlarge)

The table shows that under these assumptions, individuals who live longer will benefit financially by deferring commencement of the benefit until age 70 vs. commencing at age 62, while those with shorter lives will benefit financially by commencing the benefit at age 62.   It also shows that even those individuals who choose to defer commencement until age 70 and live until age 97 are not expected to be huge winners under the assumptions used to develop this table. 

The table also provides survival probabilities to the various ages based on the Society of Actuaries’ 2012 Individual Annuitant Mortality Table with 1% mortality improvement.  This mortality table (and the probabilities of survival) is available in our website in the “other calculators and tools” section.  It should be noted that this table represents mortality experience of individuals who purchased annuities and as such is more conservative (longer life expectancy) than general population mortality.   The probabilities of survival to age 97 for both males and females were not available from the tool on our website and have been estimated by me. 

One of the big differences between Mr. Kitces calculations and mine has to do with the amount of money spent by the hypothetical retiree from his accumulated savings during the eight year deferral period.  Mr. Kitces assumes the retiree will spend $750 per month in the first year of deferral and $922 in the seventh year ($750 increased with 7 years of inflation at 3% per year), whereas I have assumed that the retiree does not want to have a big jump in spendable income in year 8 and will spend the same real dollar amount of $1,672 the retiree expects to receive at age 70 during each year of the deferral ($1,320 per month in the first year and $1,624 per month in the 7th year).  The cost of deferrals (the present value of withdrawals from savings) under Mr. Kitces methodology is $65,258 while under my methodology, it is $114,853.  This is why deferring commencement looks so much more favorable in Mr. Kitces article (if you spend less today, you can spend more later all things being equal).  Of course, it would look even more favorable if the hypothetical retiree decided not to withdraw any amounts during the deferral period. 

As I told Leon, I’m not going to make a recommendation one way or another on whether retirees should defer commencement of Social Security.  It is an individual decision that involves many factors.   If you are willing to defer and don’t spend too much of your accumulated savings during the bridge period, you can generally increase your spendable income in your later years.