When to Start Collecting Social Security

The week before last The New York Times carried a piece on when a person should start collecting Social Security. You kids who read blogs probably didn’t even know there was a choice about when to start getting those checks or that it significantly affects how much you get.SocialSecurityposter2

Basically, the longer you wait, the higher the monthly payment. According to the Social Security Administration’s example (quoted in the article without attribution) a person whose "full retirement age" is 66, and would get $1000 a month starting then, could instead have $750 starting at age 62 or $1320 at age 70.

This dilemma, less now or more later, is faced by all those who would receive Social Security payments, which is to say just about all Americans. (We assume.) And yet it does not get that much attention. Why? Because it’s complicated. There are a lot of moving parts, including some counter-intuitive rules and strategies involving spousal benefits.

But at its core, this is not that mysterious a problem. Assuming that a person has the financial resources to wait, the first issue to consider is longevity. The average life expectancy for a 62 year-old man is 81. (It’s 84 for women.) If you’ve got good and strong reasons to expect to fall short of or exceed that benchmark, then this consideration will dominate all others. If you don’t expect to live long, start payments now. If you expect to live a good long while, wait as long as possible.

If you don’t need the money right now to pay your bills, and you don’t think your expected longevity is particularly different from the norm, then what? You’ve essentially got the choice of a number of annuities starting at different ages. That’s not as hard a problem to get your hands around as it might seem.  (And as the Times article would have you think.) Annuities are a standardized product. And there is a website (ImmediateAnnuities.com) that will give you a rough quote for an annuity that pays $X at age Y. Using it, I’ve made the following table.

Age Monthly Payment Annuity Cost PV @ I+2% PV @ I+5%
62 $ 750 $ 116,454 $ 116,454 $ 116,454
63 $ 800 $ 121,877 $ 119,487 $ 116,073
64 $ 866 $ 129,309 $ 124,288 $ 117,287
65 $ 933 $ 136,407 $ 128,539 $ 117,833
66 $ 1,000 $ 142,825 $ 131,948 $ 117,502
67 $ 1,080 $ 150,769 $ 136,556 $ 118,131
68 $ 1,160 $ 157,951 $ 140,256 $ 117,865
69 $ 1,240 $ 164,373 $ 143,097 $ 116,817
70 $ 1,320 $ 170,255 $ 145,311 $ 115,235

The first two columns are the SSA’s age and sample monthly payments. The third column is what an annuity that would pay that amount for a man of that age would cost right now, according to ImmediateAnnuities.com.

Before I go further, it should be pointed out that this is not exactly apples to apples, as the Social Security annuity is indexed to inflation and these quotes are for flat non-indexed annuities. Inflation-indexed annuities are, of course, worth more, but the website does not give easy quotes for those, so I’m going to assume that these numbers are indicative of the proportionate costs of inflation-indexed annuities.

It’s pretty obvious that $1320 a month to 70 year-old is worth a lot more than $750 a month to a 62 year-old. Really a lot more. But that’s not exactly the question we want to answer.  We want to know which is more valuable: $750 a month to a 62 year-old or $1320 a month to a 62 year-old starting in eight years. In other words, would you rather have $116K now or $170K eight years from now?

That is an elementary question of present value. To price $170K in eight years you need to find how much you would need to invest now to have that much in the future. If your rate of return on the investment was, for example, 5%, then you would need to invest about $115K today to have $170K in eight years, so the present value of $170K would be about $115K, remarkably similar to the value of the $750 starting now annuity.

Except that the $170K in the table is an inflation adjusting moving target. The 62 year-old isn’t really choosing between $750 now and $1320 later. He’s choosing between $750 now and some larger payment in the future worth $1320 in today’s dollars. So the rate of return on that notional investment that lets us price $170K in the future, what we finance types call a discount rate, needs to be in inflation-plus terms, so we get the future value in today’s dollars. To get $170K in today’s dollars from $115K now requires not 5%, but 5% over inflation. (Present value of the various annuities assuming Inflation plus 5% are in the left most column of the table.)

Inflation plus 5% is not a realistic expectation for a low-risk investment. In fact, inflation plus 2% (a little better than what TIPS are running at now) is a much more realistic assumption.  And at that rate (it’s the 4th column in the table) the annuities that start later are clearly worth more.

This is not an exhaustive analysis. Among other things, I’ve ignored the possibility of a 62 year-old not living to 70, but this hits the side of the barn. Barring special circumstances, a person is generally better off waiting to receive Social Security until as late as possible, 70 being ideal. This is the intuitive answer, and the one alluded to in the Times article, but isn’t it nice to see the argument made with numbers?

Alas, as intuitive as it is, the Times tells us that the majority of people actually choose the wrong answer, electing to receive benefits early. Why? It’s possible they are broke and need the money. But I think there is something else going on. This is a complicated topic that gets too little discussion. Without knowing for sure what the best choice is, people make what seems to be the more conservative choice, to get the money in hand now. Once again, a lack of understanding of personal finance costs real money.

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