Should a person take Social Security earlier, rather than later, and invest the proceeds in the hopes of ending up with more money during retirement?
The answer is no, according to Social Security expert William Meyer.
It is a question that Meyer says he, and presumably many financial advisors, are asked frequently.
Meyer is CEO and founder of Social Security Solutions Inc. (www.ssanalyzer.com) in Leawood, Kan., and the author of numerous research papers and articles on Social Security. He and William Reichenstein researched the issue of investing Social Security benefits. Reichenstein is Powers Professor of Investments in the Hankamer School of Business at Baylor University in Waco, Texas, and a principal of Social Security Solutions.
Social Security benefits vary depending on when the recipient starts taking them. If a person starts before full retirement age, a reduction in the monthly benefit is imposed for life. If a person waits until past full retirement age, an increase is applied each year.
The increase is approximately 8 percent a year for each year benefits are delayed until age 70. That increase also applies to the benefits received for the rest of the person’s life. There is also a built-in cost-of-living increase for all benefits.
The Social Security Administration set the reduction for taking benefits early and the increase for delaying benefits past full retirement age at a rate that is approximately actuarially fair for someone with a life expectancy of 84 years if the real, risk-free interest rate is 3 percent, Meyer says. In other words, no matter what age between 62 and 70 that a person starts benefits, if he lives to 84 he will have received approximately the same cumulative amount of money as long as the real, risk-free interest rate was 3 percent. A person's starting monthly benefits will get the least at age 62 and the most at age 70.
Meyer is basing his calculations on a full retirement age of 66, which is the full retirement age for those retiring now and for the next several years. The age will gradually be raised for those born after 1954.
However, the real, risk-free interest rate for today’s economy is 0 percent when investment expenses are considered, according to Meyer. The only way to beat the low interest rate would be to invest in all equities, which is too risky for a retirement portfolio, Meyer says. A person who wanted to buy an annuity with Social Security benefits would have to wait some time before accumulating enough to make the investment, he added.
Any investment of Social Security benefits assumes the person has enough money to live on from income or a portfolio. A person who is not full retirement age and earns more than $15,120 a year would get reduced Social Security benefits and therefore would have less to invest than someone who is older, he notes. A person living on income from a portfolio would need to be comfortable with depleting the portfolio while investing his benefits.
But those problems are actually beside the point, according to Meyer, who argues that a person cannot beat the 8 percent annual increase that is obtained from waiting to receive Social Security benefits.
“I am frequently asked by advisors, what if I take Social Security early and reinvest the proceeds? The premise is that they can beat the return on Social Security,” Meyer says. “Using an appropriate risk profile for a retiree (50/50 stock to bond portfolio or more conservative) the real return ends up being 0 percent to 1 percent anyway after removing expenses. We contend that it is virtually impossible for an advisor to beat the return on Social Security. They would have to invest in almost all equities, which misaligns the risk for a typical investment.”
Meyer bases his calculations on the 10-year Treasury Inflation Protection Securities (TIPS) rate, which is near zero, and an equity risk premium that is 1 percent below its historic average.
“Moreover, the real rate has been near zero for a couple of years and the Federal Reserve promises to keep the short-term nominal rate near zero through late 2014. So, the implications of a low interest rate environment that appears likely to persist for multiple years should be considered,” he says.