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How to Outsmart Social Security

Jack Hough

Social Security is designed to be fair, but it plays favorites. A savvy retiree can maximize benefits by choosing to begin payments at just the right time. Most choose wrong, whether from necessity or because they don't understand the system, a new study suggests.

Eligible Americans who turn 62 this year must wait until age 66 to begin receiving full payments. But they can receive smaller payments beginning as soon as age 62, or plus-size payments beginning as late as age 70.

(There are some restrictions for those who continue to work, depending on income. See "How Work Affects Your Benefits", published by the Social Security Administration.)

Monthly payments are 76% greater for a retiree who waits until age 70 than for one who begins collecting at 62, adjusted for inflation. That type of arrangement, where a person forfeits money today in exchange for receiving a larger stream of payments in the future, has a name in the investment world. It's called an annuity.

But Social Security isn't nearly as sophisticated in its pricing as the annuities offered by private companies. The latter adjust payments according to changes in interest rates to keep the benefits of waiting fairly stable, but Social Security ignores interest rates.

Annuity issuers have paid careful attention to rising life expectancies, because they increase the cost of providing lifetime payments. Social Security has made only minor adjustments to retirement ages.

Some annuities even take individual differences in life expectancies into account. Social Security treats all comers equally.

The goal of retirees should be to collect the largest possible "present value" of payments. That's not simply the value of projected future payments added together. It's the value of these payments, with each one reduced by a "discount rate," or a theoretical return that the recipient misses out on by not having the money today.

A new working paper offers guidance on how to maximize this present value of benefits, depending on the circumstance. The authors, economists John Shoven at Stanford University and Sita Nataraj Slavov at Occidental College, received a grant from the Social Security Administration for their research, but say their opinions are their own.

Shoven and Slavov based their study on Americans who turn 62 this year. Women in this group are expected to live to age 85.5 and men, 83.0. The authors consider varying marital and income statuses and interest rates.

In general, gains from delaying Social Security payments are greater during periods of low interest rates, all else held equal. They're also greater "for married couples relative to singles, for single women relative to single men, and (at most interest rates) for two-earner couples relative to one-earner couples," according to the study.

One overriding finding is that most retirees are best off waiting when "real" interest rates are below 3.5% -- in other words, when savers can safely earn no more than that amount after inflation. At the moment, real interest rates are zero, or less: Treasury bonds that adjust for inflation and have maturities of five to 10 years carry slightly negative yields.

In other words, most retirees who don't need the money and aren't sure what to do should probably wait to begin receiving payments.

Single women maximize the present value of their benefits by waiting until age 70, so long as real interest rates are below 0.8%. But even when real rates are zero (which they are), single men should wait until only 69, because of their shorter life expectancies.

At most, women can increase the present value of their benefits by 18.3% by choosing the right starting point and men by 13.3%.

Oddly enough, singles who need the money earlier should generally avoid starting payments at either age 63 or 66, the authors point out. That's because the benefits of waiting rise unevenly with age, and dimples in the data at these two ages suggest neither will maximize benefits.

For couples, each spouse must choose when to start payments, which adds complexity. Even if one spouse has never worked, he or she may be eligible for spousal benefits of up to half the "primary insurance amount" (benefit at full retirement age, generally) of the spouse who worked. If both spouses worked, the lower earner can collect worker benefits, and perhaps even a spousal benefit to bring them up to half the high-earner's PIA.

Here's when couples should collect, according to Shoven and Slavov: For one-earner couples, the earner should wait until 70 whenever real interest rates are below 2.5% (now), and not wait at all when they're above 5.3%. Assuming the earner waits until 70, the non-earner should begin payments at 66.

For two-earner couples, the difference in income matters. Suppose benefits for the low earner would be 75% of those for the higher earner at full retirement age (66 for the study group). At real interest rates of 0.6% and lower (now), both should generally wait until 70 to collect worker benefits, and the low earner should collect spousal benefits at age 66.

If all of this seems menacingly complex, it's because it is. And most retirees don't seem to maximize the present value of their benefits. Shoven and Slavov find that for groups born 73 to 82 years ago (for whom the benefits of delaying payments were significant, if not quite as large as now), about 43% filed for payments within two months of reaching age 62. For those who weren't working by 62, more than 75% were immediate filers. The authors found no consistent relationship between early filing and health status.

More-educated retirees tended to delay payments for longer, but that's not necessarily because they understood the benefits of waiting. They tend to be wealthier and were thus less likely to need the cash early.

Of course, projections on how to maximize Social Security benefits depend on the ability of the trust fund to continue making payments. With no changes to the current system, trustees say they will have enough cash to pay full scheduled benefits through 2036, followed by three-quarters of scheduled benefits through 2085. If they're right, those turning 62 this decade should stick with the study advice.

Correction: An earlier version of this story misstated the limits for spousal benefits in cases where both spouses have worked.