For the average American, the decision about when and how to take Social Security retirement benefits is an extremely important one. We know that millions of baby boomers have not saved enough for retirement. This lack of savings has been exacerbated by the past decade's subpar equity returns and the current low interest-rate environment. Add to the mix the fact that far fewer Americans participate in a defined benefit pension plan than did a generation ago, and we have the makings of a potential disaster. Clearly, millions of boomers will rely heavily on Social Security in retirement, so maximizing benefits can be essential.
Granted, the rules governing Social Security benefits and the payouts seem likely to change over time, but if history is any guide, those already receiving benefits and those approaching retirement will not be severely impacted. In any case, it seems prudent to examine options under current rules.
Although the typical client working with an advisor is likely to be in better shape financially than the average boomer, and therefore be somewhat less dependent on Social Security benefits, the importance of optimizing benefits should not be underestimated. It can add up to tens of thousands of inflation-adjusted dollars over the course of a retirement.
In 2010 (the most recent year we have statistics for), approximately 1.3 million men and approximately 1.2 million women filed for Social Security retirement benefits. Of the men, 43.6% took benefits as soon as they were eligible, at age 62. Another 26.1% took benefits after they became eligible at age 62 but before their full retirement age (FRA). Only 13.3% took their benefits at full retirement age, and only 0.6% waited until they were age 70 or older.
The situation for women is not all that different, with 49% taking benefits at age 62, another 25.2% taking benefits between age 62 and their FRA, 9.0% taking benefits at FRA, and only 1.3% waiting until age 70 or later to take benefits.
These statistics indicate that many Americans are not optimizing their Social Security benefits. That's because Social Security benefits increase approximately 8% in real terms for every year benefits are delayed from age 62 to age 70. In one test calculation that I ran, if the individual in question took benefits at FRA as opposed to age 62, the payout would have been approximately 40% more. If the person waited till age 70, the benefit would have been approximately 80% more than it would have been if he or she had taken benefits at age 62. Furthermore, retirees who take benefits before their full retirement age are subject to taxation on a portion of their benefits if they are still employed.
In certain instances, it is fairly simple to ascertain what one's strategy should be. For example, most experts agree that single retirees should base their decision on just two factors: 1) the starting date that will maximize the present value of the projected benefit, and 2) the starting date that will minimize longevity risk. Many advisors are also aware that, with respect to average single life expectancies, the Social Security actuarial tables are very fair; that is, if you assume average life expectancy (82 for men, 85 for women), the total lifetime benefit will be approximately equal, regardless of the beginning date, assuming there is no taxation of benefits. So for the single retiree, the decision about when to begin taking benefits really centers on longevity risk, assuming there is no pressing financial need at age 62. If single people in poor health are highly confident that they will not achieve the average life expectancy, they will receive a greater benefit by taking benefits sooner. In order to calculate exactly how much sooner, you'd have to know exactly when they plan to expire, so most clients in that scenario might choose to take benefits as soon as possible. For singles in good health or with a family history of longevity, waiting till age 70 might be best, if for no reason other than to provide some longevity insurance.
Once you get beyond options for singles, the question of when to begin taking benefits gets much more complicated. For example, for married couples, if both are entitled to benefits, the earnings history of both partners, as well as their single and joint life expectancies, comes into play. That's because each partner has to select a beginning date for his or her own benefits. For example, if lower-earning spouses take benefits early, they can later switch to the spousal benefits of their partners if it is advantageous to do so. You also have to consider survivor benefits. If the higher-earning spouse takes benefits early, and dies early, the surviving spouse will be saddled with a lower survivor benefit for the rest of her life.
There are many other situations we could discuss, but this is not meant to be a comprehensive study of when to take Social Security benefits, so the above example should suffice to illustrate the complexity of the issue. Given the challenges, as well as the financial stakes, a competent software tool to tackle this problem is desirable.
Historically, comprehensive financial planning software has been mediocre at best when dealing with Social Security issues. For years, many applications that I reviewed did not even let you model Social Security options other than a beginning date and an ending date. Over the last several years, some are doing a better job with Social Security benefits, but few allow you to optimize benefits and model alternatives. Fewer still allow you to specifically address the Social Security benefits election in a format that clients can easily understand.
Social Security Analyzer
Social Security Analyzer, from Social Security Solutions, is a cloud-based software application that can take much of the guesswork out of planning for Social Security retirement benefits. The firm was founded by two qualified individuals. William Meyer, an industry veteran who has developed products and services in the past for firms such as H&R Block, Advisor Software and Charles Schwab, and Dr. William Reichenstein, a professor at Baylor University who has written extensively on Social Security planning, after-tax asset allocation and other retirement-related issues.
The latest version, Social Security Analyzer 2.0, which I recently tested, does an excellent job of optimizing Social Security benefits with a minimal number of inputs. All you need are the names of the clients, their status (single, married, widowed, divorced) their birthdates, their anticipated life expectancy and their primary insurance amount (PIA). This is the amount that clients can expect to receive if they retire at full retirement age. Clients should receive this estimate annually on their Social Security statement. They can also obtain it online from the Social Security Administration. In the case of a divorced person who was married for at least 10 years and did not remarry, the former spouse's PIA, as well as the date of divorce, is also necessary to analyze all options.
Once the data is entered, you push the "get results" button. The application runs a number of calculations based on the information provided. The first result is the summary page. It contains the recommended strategy, which is computed to provide the maximum benefit for the life expectancy or life expectancies provided. It clearly displays the total projected benefit over the full period and the maximum monthly benefit. In addition, it displays the cumulative benefits at five-year intervals over the life of the plan. A graph displays the recommended plan and contrasts it with two other pre-programmed scenarios: a short life expectancy and a long life expectancy scenario. This gives the advisor and the client immediate feedback on what the impact would be, under the recommended plan, should the life expectancy assumptions be off target.
The final portion of the summary page describes the recommended strategy. For a single person, it might be as simple as selecting an appropriate starting date. For a couple, the plan could be more complicated. For example, in one scenario I ran, the recommendation was for the husband to file a restricted application for spousal benefits at age 67, and for the wife, age 66, to begin benefits based on his earnings at that time. At age 70, the husband begins taking benefits based on his earnings. When the wife reaches age 70, she switches to benefits based on her earnings record; when the husband dies, she switches to survivor benefits.
Tabs across the top of the page give you access to additional functionality. The analyze tab provides a detailed description of the recommended plan. You can toggle between the recommended plan and the long or short life expectancy scenarios with the push of a button. A compare tab contrasts the recommended strategy with taking benefits early, at full retirement age or late. The summary page displays the recommended plan and a few others (early, FRA, delayed) under multiple life expectancy scenarios. There is also the ability for users to construct their own strategies and compare them to the ones provided by the program by default. For advanced users, the Advanced tab allows users to change assumptions about discount rates, COLA, life expectancies, tax rates, percent of Social Security taxable and client earnings in the years before retirement (age 62-66).
The reports tab allows users to create both a default and custom templates that output some or all of the factors we've discussed above in PDF format. The report template allows users to input some custom introductory text. It also includes a required disclosure page. The report provides an explanation of why the recommended strategy was selected, in plain English, and it discusses under what circumstances the recommended strategy might not be the best one. There's even a break-even analysis comparing two strategies, for example taking benefits early versus following the recommended plan. If you entered a recommended annual income need, the report will specify what percentage of that need will be met by Social Security income. Overall, I judged the report to be very well done.