Delayed Social Security Retirement Benefits as an Investment
We often hear the following question: "Can't I take my retirement benefits at age 62, invest them, and do better financially than I could by waiting for higher benefits?" The answer to this question for the typical investor is usually "NO," provided you are making a fair comparison with other low-risk investments. In the following article, we explain our answer as it applies to single persons. Later, we take up the more complicated case of married persons.
Waiting past age 62 to claim your benefits seems costly: you forgo cash in hand. But waiting also offers a substantial advantage: each year you delay claiming, your benefits increase for the rest of your life. And, those benefits are inflation protected. The tradeoff between smaller monthly benefits immediately versus larger benefits later can be expressed as a rate of return (or an interest rate) on an investment. This rate of return measure can then be easily compared to other investments.
To illustrate, suppose you could get $9,000 a year in benefits by claiming at 62. If you waited until age 63 to claim you would get $9,600. So, you give up (invest) $9,000 in order to get $9,600 (inflation adjusted) for the rest of your life. If you are a male with a normal life span of 82 years, the implied annualized rate of return on such an "investment" is 2.9%. A female with a normal life expectancy of 86 would receive a rate of return of 4.2%, since she receives the extra money for more years. Note that these are inflation-adjusted rates of return. If the average COLA over the next 25-or-so years is 2%, then the "nominal" rates of return (not adjusted for inflation) for the illustration above would be 4.9% and 6.2% respectively.
Generally, we think about interest rates or rates of returns in nominal terms, rather than in inflation adjusted terms. So, in what follows we will use nominal rates of return, assuming a long term inflation rate of 2%.
The figure below shows the various rates of returns to waiting an additional year for both single males and females. We have discussed the rates of return from waiting until age 63; in the figure those numbers are indicated by the first two bars (left for males; right for females).
If you are now 63, what's to be gained from waiting until 64? The figure shows that men with a normal life expectancy would capture an annualized rate of return of 7.1%. For women, it is 8.3%. The interpretation for other waiting periods follows the same pattern.
By comparison to the nominal yields shown in the graph, 10-year Treasury bonds (close to a risk-free investment, like Social Security) are currently yielding about 2.0% annually if held to maturity, while 30-year Treasuries are yielding about a 3.2% annualized return to maturity.
So, if you compare the implied rates of return to waiting for Social Security benefits with comparable very low risk investments, you can see that waiting can be a superior investment strategy. (Using stocks in the comparison is not appropriate since they involve far more risk than what we are considering here.)
For singles, it is important to note that the rates of return to waiting depend only on life expectancy. The absolute level of benefits is irrelevant to the calculation. So, for singles with life expectancies longer than normal, the rates of return to waiting are higher than those shown above. With below-average life expectancies, the rates of return are lower.
Married couples also wonder how long they should delay claiming retirement or spousal benefits. However, answering this question for many married persons is more difficult than answering it for singles because couples face far more choices for claiming.
We can make the following generalization. Many couples currently have an opportunity to take advantage of the restricted application strategy and receive what we refer to as "free" spousal benefits. As a result, they can get higher rates of return to waiting, since this valuable strategy is not available to singles. In other words, the rate of return profile available to singles represents the minimum profile available to a couple. Often, they can do better, but changes to Social Security enacted as part of the Bipartisan Budget Act of 2015 limit the applicability of the restricted application strategy to those born before 1954. Below we offer just one example to illustrate how much a couple might stand to gain-as measured by rates of return--by waiting to claim their benefits.
For married couples, relative ages and retirement benefits play important roles in optimal claiming choices and rate of return calculations. Here we assume 1) that the husband (Ted) is age 58 years while the wife (Nancy) is 61, and 2) that Ted's monthly benefit at full retirement age is $2300, while Nancy's is $1500. Both have normal life expectancies-82 for Ted and 86 for Nancy.
Our benefits calculator for married persons shows that the optimal claiming pattern is for Ted to claim retirement benefits at age 62, and then for Nancy to claim spousal benefits at age 66 while letting her retirement benefits grow until claiming them at age 70. For our rate of return illustration, we assume that Ted behaves optimally, claiming at age 62. Then we consider the rates of return to waiting available to Nancy as she considers all claiming ages from 62 to 70. These nominal rates of return are shown in the figure below.
The rates of return available to Nancy for the first four time periods are the same as those available to a single female, since no special strategies are available during those years. Once she turns 66, however, she has opportunities to capture astounding rates of return by waiting further.
To illustrate, by claiming her retirement benefits at 67 rather than 66 (but claiming spousal benefits at 66), she earns an annualized rate of return of 36.2% over the next 20-or-so years on her "investment" in forgone retirement benefits. Further, by waiting until age 68 to claim retirement benefits, she earns 27.1% on the "investment" in forgone benefits from not claiming at age 67. As the figure shows, Nancy can capture very high rates of return from waiting right up to age 70. Clearly, there is no way she will get similar rates of return in alternative low-risk investments such as Treasury bonds.
Rates of return to delaying Social Security for married couples vary with age differences, benefit differences, and life expectancies, but the fact that delaying Social Security offers reasonable-to-extraordinary rates of return along with first-rate inflation protection means that planning to claim Social Security as early as possible and invest it is often a flawed strategy for a married couple.