Monday, November 14, 2016

Deferring Commencement of Social Security Benefits is Ok, Deferring Retirement is Better—Part II

This post is a follow-up to our post of April 28, 2014, where we looked at the effect on a hypothetical 65-year old’s annual spending budget under the following scenarios:
  1. Retiring at age 65 and commencing Social Security immediately, 
  2. Retiring at age 65 and deferring commencement of Social Security until age 70, and 
  3. Continuing to work 5 more years, retiring at age 70 and commencing Social Security at 70.
We concluded that while Scenario #2 might increase one’s spending budget by something in the neighborhood of 5%-10% over Scenario #1, Scenario #3 might increase one’s spending budget in retirement by 40% or more.

Now, in a recent study entitled, “Is Uncle Sam Inducing the Elderly to Retire”, the authors use some mysterious (to me) methodologies to conclude that the financial benefits of continuing to work an additional five years is much lower than the 40% figure we previously developed.  The authors conclude, “We find that if all elderly now working were to continue to work for five more years, they would, on average, raise their sustainable living standards (annual discretionary spending per household member with an adjustment for economies in shared living) by roughly 5 to 8 percent depending on their age and position in the resource distribution.”

As an actuary, my first reaction is to look at some numbers to see what they support.  So let’s use the Actuarial Budget Calculator (ABC) to look at a 65-year old male making $50,000 per annum gross wages.  Let’s assume he has $200,000 in accumulated savings and his home equity will cover his future expected non-recurring expenses. 

If we go to the Social Security Quick Calculator, we see that if this hypothetical individual retires and begins commencement of his Social Security benefit immediately, he would receive approximately $1,275 per month based on the assumptions made for his prior earnings history by the calculator.  The calculator also indicates that if he has no future employment income but he defers commencement of his benefit until age 70, his age 70 benefit in today’s dollars would be approximately $1,806 per month, and if he continues to work until age 70, his age 70 Social Security benefit would be $1,932 in today’s dollars.

Let’s assume that our hypothetical individual desires to have future spending budgets keep pace with inflation and uses the assumptions we recommend for the ABC.  He has no bequest motive.

For Scenario #1 (inputting an annual Social Security benefit of $15,300 – monthly benefit of $1,275 – starting immediately and $200,000 of accumulated savings), we get an annual spending budget of $24,011.

For Scenario #2 (annual Social Security of $23,928 – monthly benefit of $1,806 increased by 5 years of assumed inflation starting in 5 years), we get an annual spending budget of $25,842, an increase of 7.6% over Scenario #1.

For Scenario #3, we input an annual Social Security benefit of $25,597 (a monthly benefit of $1,932 increased by 5 years of inflation) starting in 5 years.  We then go to the new pre-retirement tab and assume that our hypothetical individual will receive annual 2% per annum pay increases, will save 10% of his pay each year and will not receive any additional pre-retirement income (such as a matching employer contribution).  Under this scenario, our hypothetical individual is expected to have a real dollar spending budget of $45,000 for 5 years and, at age 70, his real dollar spending budget is expected to decrease to $35,530 and remain at that level for the rest of his life.  Note, however, that this ultimate real spending budget is almost 48% higher than the Scenario #1 spending budget. 

Yes, he will have FICA taxes, income taxes, work-related expenses and savings that will need to be paid while he continues to work.  However, he had these expenses in prior years, so these are not new for him if he continues to work.   And, yes, he will not be receiving Social Security benefits while he works (of course he could if he wanted starting at his Social Security Normal Retirement Age of 66, but he decides to defer).

The authors are undoubtedly correct that there is some confusion in the general population regarding how the Social Security Earnings Test works.  For most readers of this blog, however, the concept is not that difficult.  Per “How Work Affects Your Benefits” prepared by the Social Security Administration, “You can get Social Security retirement or survivors benefits and work at the same time. But, if you’re younger than full retirement age, and earn more than certain amounts [generally $15,720 for 2016], your benefits will be reduced.  The amount that your benefits are reduced, however, isn’t truly lost. Your benefit will be increased at your full retirement age to account for benefits withheld due to earlier earnings.”

In their analysis, the authors assume that the Earnings Test is a “pure tax on benefits”, i.e., they ignore the increase in future benefits that results.  We respectfully disagree with the reasonableness of this assumption and, as a result, find the author’s conclusion misleading.

Bottom line:  I’m not buying the author’s argument that Uncle Sam is inducing the elderly to retire through operation of its tax and subsidy policies.  Of course, results will vary from individual to individual.   For most people, however, there is still plenty to be gained financially by continuing to work.  But, don’t just take our word for it.  Use our Actuarial Budget Calculator spreadsheet to crunch your own numbers.