There aren't many things good about a zero-interest-rate-policy world for retirees or those planning their retirement. But researchers say there is one bright spot.
Most households benefit from waiting to claim Social Security when real interest rates are close to zero, as they are now, according to research just published by National Bureau of Economic Research.
That's even true for households with mortality rates that are twice the average, according to the authors of the paper, John Shoven, an economics professor at Stanford University and Sita Nataraj Slavov, a researcher at the American Enterprise Institute.
"As Social Security benefits are paid as a life annuity, delayed claiming reduces the expected length of time over which benefits are claimed," the authors wrote. "Thus, the benefit calculation rules call for an actuarial adjustment so that individuals who claim later receive larger monthly payments."
The authors say it is widely believed that this adjustment to benefits is actuarially fair, meaning that, on average, individuals can expect to receive the same present value of benefits regardless of when they claim. In other words, those who don't expect to live a long time would benefit by claiming benefits early; those who expect to live a long time would be better off delaying.
However, the researchers say this claim is false, particularly in today's environment of near-zero real interest rates. "Instead, delay appears to be actuarially advantageous for a very large subset of the population," the authors wrote.
In fact, a couple could add upward of $250,000 to their overall Social Security benefit by using an informed claiming strategy. The reason, according to Shoven and Slavov, is this: "Delaying Social Security is equivalent to purchasing an annuity," they wrote. "An individual who delays forgoes benefits during the delay period in exchange for an increase in benefit payments for life."
According to Lita Epstein, author of the "Complete Idiot's Guide to Social Security and Medicare," each year you delay Social Security after reaching full retirement age, which for baby boomers generally is 66, you get an 8% increase in benefits. "That's a 32% increase in benefits if a baby boomer waits until 70," said Epstein.
In the private sector, companies that sell annuities generally adjust their terms frequently, making payouts less generous when mortality improves (which increases the expected payout) or when interest rates fall (which reduces the return that can be earned on funds that are used to purchase the annuity), the authors wrote.
But that's not how Social Security works. In fact, the terms for delaying Social Security have, in many cases, become more generous over the past several decades despite improvements in life expectancy and fluctuations in real interest rates.
Of course, few households wait to take their Social Security. In fact, most households claim Social Security at the earliest possible age, 62. But in general that is not in their best interest. "No one defers Social Security and almost everyone should," said Shoven.
In their paper, Shoven and Slavov examined the data every which way. They looked at the actuarial advantage or disadvantage of delay for individuals whose life expectancy differs from average. They also looked at the benefits of delaying for single males, single females, one-earner couples, and three two-earner couples from different race and education groups, using mortality rates that are differentiated by race and education.
In short, they left no stone unturned.
And what they found is this: A "delay" strategy is particularly beneficial for married couples, according to Laurent Belsie, a writer for the NBER Digest. The primary earner can delay claiming benefits, while the secondary earner takes benefits early. If the secondary earner outlives the primary earner, he or she gets to step up to the primary earner's benefits.
That strategy helps married two-earner couples most, but married one-earner couples also benefit. "Delaying the primary earner's benefit is equivalent to purchasing a second-to-die or joint life annuity," the authors wrote. "In contrast, a single person who delays claiming only receives a single life annuity based on his or her own earnings record."
Take money first from retirement accounts
So what's the point, you might ask?
Shoven and Slavov say the results have important implications for financing retirement in the presence of defined-contribution balances.
"Financial planners often advise individuals to use defined-contribution balances to purchase an annuity, using the annuity income to supplement Social Security benefits. That is, the two retirement resources -- Social Security and defined-contribution balances -- are consumed in parallel," the authors wrote. "However, in today's low-interest rate environment, this standard strategy is suboptimal for most retirees."
That's because terms for delaying Social Security are more generous than the terms for purchasing a private annuity. And two, as Social Security payments are adjusted for cost-of-living increases, delaying Social Security buys an annuity whose payments remain constant in real terms; such annuities are virtually unavailable in the private market.
In other words, the better strategy in what some call a ZIRP world is to draw down money from your 401(k) and IRAs to finance a delay of Social Security. That, say the authors, "is likely to generate higher retirement income than using them in parallel."
Others have suggested this tactic before. But this research goes a long way toward proving that the strategy is wise for many Americans, especially with real interest rates near or below zero.
Not surprisingly, many experts praised Shoven and Slavov's work and all the good that could come of it. "It has always been assumed that for a person with average life expectancy, it doesn't matter when you claim Social Security," said Elaine Floyd, CFP, director of retirement and life planning at Horsesmouth.
"Whether you start a smaller benefit at 62 or a larger benefit at 70, the net present value of the lifetime income stream would be the same. Shoven and Slavov show that when interest rates are close to zero, as they are now, the calculation changes," she said.
Once people understand how much more money they will have in the long run by delaying Social Security, Floyd said they will choose to wait.
Some firms are already using the claiming strategies that maximize the overall benefit as described in Shoven and Slavov's paper.
"We also often recommend the higher-income-earning spouse delay to as late as age 70 and have the lower-income-earning spouse take their benefit at their full retirement age or as early as age 62," said Nicholas Brandt, CFP, a wealth planning senior analyst at Fifth Third Private Bank.
"The idea of this strategy is to maximize the benefit received by the entire household," he said.
Others concur. "From all angles the results are clear, creating a strategy that maximizes benefits and is sensitive to longevity risk can garner an American retiree a lot more money," said Bill Meyer, CEO of Social Security Solutions Inc.
What's more, he said, his research has uncovered two key lessons that are consistent with Shoven and Slavov's work:
"One, the relevant life expectancy for the decision as to when the spouse with the higher primary insurance amount should begin benefits based on his earnings record is the lifetime of the second spouse to die, while the relevant life expectancy for the decision as to when the spouse with the lower primary insurance amount should begin benefits based on her record is the lifetime of the first spouse to die," Meyer said.
And two, if at least one spouse lives well beyond the age that the higher earner turns 80 then the couple's cumulative lifetime benefits will be higher if he delays benefits based on his record until age 70, Meyer said.
"Social Security: When to Start Benefits and How to Minimize Longevity Risk," is a paper Meyer co-wrote with Bill Reichenstein, head of research at Social Security Solutions Inc.
It may not be right for you
To be fair, as is often the case with most research of this sort, experts agree in general with the research findings about the financial benefit of delaying Social Security. But they also say you shouldn't blindly follow the recommendations. Instead, you should decide what works best based on your own fact patterns.
For instance, Rob Kron, head of investment and retirement education at BlackRock, agrees overall with the Shoven and Slavov conclusions. But he also notes that what happens in research doesn't always happen in reality.
"One of the things I may offer that is different is I believe their work assumes people have perfect knowledge of their options," said Kron. "Based on my personal experience in speaking with financial advisers and investors as much as I do, that is an incorrect assumption. So while having the math to prove that one option is better than another, I think education about options and strategies is more important."