When to claim Social Security is as much a dilemma for advisors as it is for their clients, and that motivated our firm to research how to resolve it. A recent paper on our research does in fact propose a solution that provides more certainty and clarity and may lead to higher long-term Social Security benefits.

Despite the clear advantage of deferring benefits to 70, which offers higher benefits over the life of a beneficiary, and is a way to mitigate longevity risk, few retirees actually do that. Based on the Social Security Administration’s records, only 4 percent of women and 2 percent of men claimed benefits at 70 in 2013, compared with 27 percent of women and 34 percent of men who claimed it at full retirement age of 65 or 66. A recent study by Nationwide found that among those who claim benefits early, 25 percent indicated that they did not think that they would live long enough to make it worth optimizing benefits. Clearly, mortality concern is a key factor in retirees’ decision on when to claim Social Security. Given that the average life expectancy for retirees at 65 is about 84.3, retirees appear to have a reasonable expectation of their mortality risk.

A Leverage Strategy

In order to address clients’ mortality concern, our paper proposes that retirees can claim benefits early at 66, and invest the proceeds from 66 to 69 in a way that would result in more money in the long run than deferring benefit claim to 70. The strategy, in effect, transforms full-retirement-age benefits into long-term retirement resources, thereby mitigating both mortality and longevity risks. How well the strategy works is laid out in detail in our report on our website, http://www.plenarisadvisory.com/files/59550/Social%20Security.pdf. This article summarizes the methodology and the key findings of the report. Our overall finding is that the strategy will work and will enhance a retiree’s retirement resources consistently to age 100. 

Methodology

The proposed strategy is based on three components: the beneficiary population, the benefit amounts for early and deferred social security and the leverage options.

1. The Beneficiary Population

The study focused on five beneficiary scenarios in order to assess how effective the strategy is for each beneficiary category. 

Scenario 1 covers single retirees, both male and female. Scenario 2 covers a couple, each of whom is entitled to the same benefit and is identified as “couple with 200 percent benefit” in this study. Scenario 2A covers the same couple as Scenario 2, but with one spouse dying at life expectancy of 85.  Scenario 3 covers a couple with one spouse claiming Social Security as a spousal benefit, and is identified as “couple with 150 percent benefit,” which amounts to 75 percent of the benefit of the couple in Scenarios 2 and 2A. Finally, Scenario 3A covers the same couple as in Scenario 3, but with one spouse dying at life expectancy of 85. 

All beneficiaries are assumed to have relatively high income that puts them in the 28 percent tax bracket and enables them to defer benefits to 70, a key variable for this proposed strategy. 

 

2. The Benefit Amount

Since all beneficiaries are assumed to have high income, the benefit amount would start at $30,000 per person per year at age 66, except for the spousal benefit which is 50 percent of the full amount. (The maximum benefit for 2016 is $31,668.) The deferred benefit amount claimed at 70 is 32 percent more than the benefit accrued from 66. The Social Security Administration has estimated that 2.7 percent would be the average cost of living adjustment (COLA) projected to 2024, and our study assumed that the benefit amount will increase by 3 percent per year from 66 to 100.  

Since the beneficiaries are high income, all full-retirement-age and deferred Social Security benefits are subject to 28 percent income tax on 85 percent of the benefit amount. All findings of this study are based on the comparison of the net benefits for full-retirement-age and deferred benefits from 66 to 100.

3. The Leverage Options

We tested our leverage strategy by investing net benefits claimed at age 66 in five vehicles described below as Options A to E. 

For Option A, the leverage is based on investing net benefits in such market assets as stocks and bonds at a 5 percent return in a low cost tax-deferred account with no withdrawal.

For Option B, the net benefits are invested similarly as Option A at a 5 percent return, but they are held in a taxable account. Proceeds from this option provide the funding for further investments in other potential options, such as Option C, an annuity, or Option E, long term care insurance. 

Option C uses an annuity that would be funded to generate income to match the additional Social Security benefits from deferral. The data for the annuity are broken down by gender, as well as for single and joint policies. All annuity data are derived from the website www.immediateannuities.com, and are presented net of tax.

Option D invests the net benefits in an index universal life policy at 6 percent internal growth, which provides a death benefit and cash value as a cash reserve, as well as a potential retirement income starting at age 80 or 85. Data for this option are based on illustrations from Allianz Life Insurance Company, www.allianzlife.com.

Option E uses net benefits to buy a long-term-care policy. The policy data for this option are derived from Lincoln Financial Group’s long-term-care policy known as MoneyGuard II, www.lfg.com.

 

Findings

The results of the study are summarized in Table 1, which displays 50 potential outcomes. Thirty-six (72 percent) of the outcomes, marked in blue, indicate positive support for the strategy to age 100 and beyond. Fourteen (28 percent) of the outcomes, marked in red and P, show that leveraging the net benefits at age 66 in some cases would produce the same benefit as deferred Social Security benefits up to age 97. The overall result suggests that this leverage strategy unequivocally provides greater benefits to the beneficiaries until they are in the high nineties, and confirms that it would mitigate both mortality and longevity risks.    

 Not only does the strategy offer greater benefits, it in fact offers significantly greater benefits, depending on the leverage option selected. Twenty of the 36 positive outcomes register net benefits that exceed $100,000, ranging from $130,031 to $676,472. 

The best outcomes are found in Scenario 2A, where the strategy consistently shows positive results across all leverage options. Since Scenario 2A denotes a survivor scenario, the result means that frontloading Social Security is actually highly beneficial to the surviving spouse, and is contrary to the conventional belief that delaying Social Security to 70 would ensure that the surviving spouse would get more income. 

 

The underlying reason for this result is that Social Security would terminate when one spouse dies, yet the leveraged benefit that flows from the early claim would have been realized or is continuing for the survivor.

The outcomes in Table 1 show that not all leverage options work well for all beneficiary scenarios. For single beneficiaries, Option D (IUL) appears to be less effective than Option E (long term care). For couples, a joint annuity (Option C2) provides less benefit than a combination of two single policies (Option C1). This means that advisors need to assist their clients in assessing the effectiveness of each potential leverage option in the context of their unique retirement needs and risks. Since both universal life and long-term care are insurance related, underwriting requirements may prevent some clients from using these options.

Despite the disparity in benefits, the outcomes for the couple with lower benefits in Scenarios 3 and 3A track the outcomes for the couple with higher benefits in Scenarios 2 and 2A. This means that the strategy would work for beneficiaries with varying income.

The results for Options A and B indicate that, if a market investment can achieve a return that is 1 percent to 2 percent above COLA, the strategy would work with these options. In this case, Option A represents a 2 percent return above the 3 percent COLA, and is positive across all beneficiary scenarios.  Option B amounts to a tax-adjusted return of 3.6 percent, which also shows positive results until age 100 in some scenarios. While Options A and B may incur market risks, a return of 1 percent to 2 percent above COLA is reasonable and should be achievable.

Conclusion

The results of our study confirm that the proposed leverage strategy would enhance retirees’ income consistently to age 100 and would provide more certainty and clarity for clients regarding Social Security. As part of the client’s best interest standard under the new DOL fiduciary rule, advisors may need to apply this strategy to ensure that clients have an opportunity to assess the full potential of their benefits before making any decision on claiming Social Security.  

Eva L. Levine, JD, CFP, RIA, is the principal of Plenaris Advisory, based in San Jose, Calif. The firm offers comprehensive financial planning in the San Francisco Bay Area.