“Break Even” No Way to Decide When to Claim Social Security

As noted last week, a recent blog suggesting that people delay claiming Social Security ran into a buzz saw of hostile comments.  The argument was that people should use their financial assets to support themselves early in retirement so that they could gain an actuarially increased monthly benefit that would enhance their security. 

One group expressed great anxiety over whether Social Security would be there if they waited to claim.  The answer is that people have a right to be angry that a financing shortfall existing for decades has not been addressed.  But the fix is conceptually simple, fiscally manageable, and just requires political will.  Social Security will be there.

The other group worried that they would not “break even.”  That is, they would not live long enough to make up for the benefits they missed by not claiming at age 62.  But monthly benefits at 62 are actuarially reduced to reflect the fact that people claiming at 62 will receive benefits for about 8 more years than someone claiming at 70.  This adjustment is substantial.  For example, an individual who stops working at age 62 but waits to claim benefits at age 70 will receive 76 percent more (real) dollars per month for the rest of his life, than if he claimed benefits at age 62.  

Prior to 2008, the Social Security Administration actually offered a break-even analysis to help individuals chose their claiming age.  People were told what their benefits would be at 62 versus, say, 65, that they were “forfeiting” benefits by claiming later, that the deferral would result in a higher monthly benefit from 65 on, and that they would “come out ahead” by claiming later only if they lived to some specific age, when the cumulative benefit payments under the two claiming ages were equal. 

The problem with this simplistic financial calculation is that it places little value on what people receive beyond the break-even date.  People are averse to risk and knowing that they will receive the higher benefit for the rest of their lives is extremely valuable.  Moreover, the goal is not to get the most dollars from Social Security, but to have an adequate retirement income.  For the great majority of households now entering retirement, securing an adequate income is the most critical financial problem they face. 

It is true that people who claim Social Security early will get more dollars if they die “too soon.”  But they will get less if they live “too long” and receive the actuarially reduced benefit over an extended period.  They will be forced to scrape by with less in their 80s and 90s.  People in reasonably good health are more likely to live “too long” than die “too soon.”  Moreover, in the case of couples, the claiming age of the higher earning spouse matters a lot, since the surviving spouse is entitled to the higher of her own or her spouse’s benefit.  A husband age 65 and wife age 63 with average health, face a 50-50 chance that at least one spouse will live to age 91.  That’s well past the “break-even” age.  

The Social Security Administration has abandoned the break-even framework for the claiming decision and now simply lays out the benefits at different ages.  The wisdom of that decision was highlighted by a recent paper which reported an experiment where individuals were told their retirement options using a host of different frames.  The frames varied along three dimensions: (1) consumption versus investment; (2) gains versus losses; and (3) older versus younger reference ages.  The key finding, however, is that the break-even frame encouraged people to move up their planned retirement age by 12 to15 months compared to any manner of framing the choice.  Thus, Social Security had been inadvertently encouraging people to claim early. 

Claiming later is the most important step towards ensuring a secure retirement.  For people in average or better health, break-even analysis is not a helpful way to make this important decision.  The goal should be to get as much monthly inflation-indexed income for life as possible.