Accounting for Social Security Claiming Behavior

by Svetlana Pashchenko, University of Georgia

Why do most individuals claim Social Security benefits before the full retirement age? Individuals can claim benefits at any age between 62 and 70.  Early claiming (before the full retirement age) results in permanent reduction in basic retirement benefits, while late claiming results in its permanent increase.  These penalties and rewards can be substantial: for example, for the cohort of individuals born in 1937, claiming at age 62 vs 65 resulted in 20 percent reduction in monthly benefits, while claiming at age 70 vs 65 resulted in more than 30 percent increase.  Yet, among men born from 1936-1938, 67 percent claim benefits earlier than the full retirement age.

Choosing the age of claiming benefits is equivalent to deciding how much, if any, annuity income to purchase.  Every year of delay in claiming results in increase in pension benefits, i.e., an additional lifetime annuity income, while the ‘price’ of this annuity is one year of foregone benefits.  In this light, the reluctance of individuals to delay claiming can be interpreted as a lack of willingness to annuitize.  This behavior is consistent with a well-documented annuity puzzle: a standard life-cycle model predicts that individuals should annuitize a large fraction, if not all, of their wealth, while in the data, we observe only a few people buying private annuities.  A common conclusion from the literature on this puzzle is that several factors can play a role in decreasing demand for private annuities, among them, market frictions such as adverse selection and the existence of minimum purchase requirement (e.g., Pashchenko, 2013).  However, these explanations do not apply when it comes to explaining low demand for public annuity provided by Social Security, making it a harder puzzle to explain.

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