The following is in response to Joe Tomlinson’s article, An Innovative Solution to Retirement Income, which appeared last week:
Dear Editor,
One important disadvantage to the deferral option for Social Security (SS) benefits is that taking early benefits preserves wealth since the recipient can keep and invest the money. If he lives a long life, these savings can accrue to his beneficiaries.
SS is a poor protector of savings as there is only a $200 insurance policy for SS recipients. Imagine you accumulated a stream of SS payments for 10 years—from age 67 to 77 ($2,000 per month or $24,000 per year less taxes for 10 years). Assuming a reasonable return you could have between $200,000 and $300,000 saved, money that could be passed on to beneficiaries. (My assumption is that the money wouldn’t be spent since the author is suggesting a deferral strategy that means the money isn’t need for living expenses.) If the recipient begins taking SS in the 11th year, his monthly payment might be in the neighborhood of $5,000 per month or more depending on inflation. If he lives, he might catch up to the up front-payment strategy but the returns on that money would make for an interesting comparison. But the downside is that, if he dies in that 11th year all of those ten year savings are gone!
I would also find it interesting if the amount saved in the distribution strategy was used to buy an immediate annuity at age 77. The monthly payment is likely to exceed the deferred-distribution strategy by a bundle.
Thomas E. Nugent
Chief Investment Officer
Victoria Capital Management, Inc.
Hilton Head Island, SC
Joe Tomlinson replies:
Mr. Nugent’s raises an important question about the Social Security (SS) delay – whether if it might work better to take SS earlier and invest the extra funds in the stock market – in other words, grab the money as early as possible and get it invested.
I ran some numbers based on the example used in the article. I assumed inflation of 2%, a TIPS rate of 0%, and real returns for stocks of 5.5% with 20% volatility. (The 5.5% was based on a 2011 survey of 6,000 economists and other financial professionals.)
I estimated life expectancies for healthy, non-smoking, white-collar individuals intended to be typical clients of financial advisors – 20 years for a 66-year old male, 22 years for a 66-year old female, and 30 years (for the last to die) for a couple where the husband is 66 and the wife 64.
I then ran the same example used in the article. The SS benefit at age 66 was assumed to be $20,000. Delay credits would boost the benefit to $26,400. The particular goal in this case was to produce $26,400 of income beginning immediately to cover basic living expenses. One way to do this would be to delay SS to age 70, and set aside $109,000 to cover expenses during the four-year interim period. Under this approach, the $26,400 of annual expenses would be covered regardless of length of life, but nothing would be left of the $109,000 for a bequest after the four-year interim period.
I tested the alternative strategy suggested by Mr. Nugent of beginning SS immediately at the $20,000 level, investing the $109,000 in the stock market, and taking withdrawals to make up the difference between the $20,000 and the needed $26,400. I then calculated expected bequest values at life expectancy and probabilities of running out of money while still living.
Here are the results:
Social Security Delay Test |
|
|
|
|
Scenario |
Life Expectancy |
Expected Bequest |
Present Value of Bequest |
Probability of Failure |
Male Age 66 |
20 |
$61,542 |
$14,488 |
33% |
Female Age 66 |
22 |
$48,950 |
$9,972 |
39% |
Couple F64/M66 |
30 |
$0 |
$0 |
55% |
For either a single male or female, the "grab the money early" approach does produce a non-zero expected bequest. However, the probabilities of running out of money while alive and not being able to pay for basic living expenses are alarmingly high. For a couple, the table shows the enhanced value of the joint-life annuity built into SS via the survivorship benefit – the "grab the money" strategy produces zero expected bequest value (same as the SS delay strategy) and produces a greater than 50% chance of running out of money while at least one member of the couple is still alive.
These results provide another way of demonstrating the value of delaying SS, particularly for married couples.
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