Substantial research indicates that most Americans are retiring with far too few resources to finance their desired standard-of-living in old age. Typical retiree savings, in fact, can cover only a few years of median U.S. household spending. No wonder, then, that Social Security looms so large in retirement resources. Two in five elderly individuals receive half or more of their income from the system. Close to one in eight are entirely dependent on its benefits. Even those of greater means need the system’s support. Future benefit claims represent the second largest retirement asset for a significant fraction of high-income older consumers.
There are many reasons retirement can be a period of financial strain for older Americans. The list includes retiring too early, over-reliance on employers’ retirement plans, poor investment returns, the dearth of employer-provided pensions, inadequate or inappropriate financial planning, higher than expected Social Security benefit taxation, unanticipated Medicare B premia and other out-of-pocket health care costs, ignorance of the range of available Social Security’s benefits, not to mention the arcane rules governing their collection, and underappreciation of one’s potential longevity.
Regardless of the cause, thousands of workers may be retiring each day facing the prospect of running short of money. Given this reality, maximizing lifetime Social Security benefits is of utmost importance. Yet, as our recent study shows, it is probable that a large number of retirees fail to do so. (Disclosure: The study relies on Kotlikoff’s commercial Social Security lifetime benefit optimizer.) This is lamentable given that maximizing lifetime benefits simply requires filing for the right benefits at the right time, generally when monthly starting-amounts peak.
Social Security’s retirement benefit provides high returns to patience, with benefit amounts 76 percent higher, adjusted for inflation, when started at age 70 rather than, for example, at age 62. These huge gains from benefit-collection patience hold for younger as well as older workers despite Social Security’s advancing full retirement age.
The 76 percent differential reflects two things. First, waiting to file avoids the early-retirement reduction penalty associated with early benefit collection. Second, waiting beyond full retirement age to begin collecting is rewarded in the form of Delayed Retirement Credits (DRCs). DRCs increase your retirement benefit by eight percent for each year, through age 70, that your retirement benefit receipt is postponed.
Both of these “actuarial adjustments” compensate for a shorter expected duration of benefit receipt when the benefit collection is delayed. Indeed, they more than compensate due to the high interest and mortality rates that prevailed when these adjustments were set in law. But the real bonus from postponing the start of benefits is being able to purchase, from Social Security itself, additional longevity insurance — insurance against outliving one’s savings. The premium here is the foregone benefits. The additional insurance is the higher payment if one lives longer than expected.
Living well beyond one’s life expectancy is of paramount economic concern, requiring that individuals prepare for the possibility of living to one’s maximum age of life — maybe a best case scenario in general but a financially worst-case scenario for the unprepared. Social Security insures against this risk by paying us inflation-indexed benefits for as long as we live. Calculating lifetime Social Security benefits requires including their value when they are needed the most — beyond life expectancy, indeed right through the maximum age of life. Yet if you Google “life expectancy”, a multitude of hits will appear, many on Social Security webpages. Google “maximum age of life” and very few will surface.
This focus on life expectancy may be leading workers to systematically undervalue Social Security’s lifetime benefits and the gains from patience. As we find in our research, the vast majority of Americans – over 90 percent in our study – are likely to benefit if they wait until 70 to initiate their retirement benefits. Yet, just six percent do so. Worse, we project that close to 70 percent of today’s non-disabled workers will take their retirement benefits at or before age 65. Roughly one in three will collect at 62 — the earliest age at which benefits are available.
Sub-optimal collection of retirement, spousal, widower, divorcee spousal, divorcee widow(er), child, disabled child and parent benefits comes at a huge price. Today’s typical middle-age and older workers will, we estimate, leave over $182,000, present valued, on the table by not collecting the right benefits at the right time.
In our estimates, optimizing would permit a 10.4 percent increase in typical age 45–62-year-old workers’ lifetime living standards, starting immediately (since one’s required saving declines when the timing of benefit receipts is optimized). For one in four, the potential living-standard gain exceeds 17 percent. For one in 10, the gain exceeds 26 percent. Among the poorest fifth, the median living standard increase is 15.9 percent, with one in four gaining more than 27.4 percent.
It is true that waiting until age 70 to collect benefits would exacerbate some retirees’ cash-flow constraints. But, as our paper suggests, the impact is, on average, rather small — entailing a 7 percent reduction in pre-age-70 spending for those facing such constraints.
To be sure, the loss may be more acutely felt by lower-wealth households that are more likely to be cash-constrained households. This could be addressed, for example, by permitting retirees to take a share, say 25 percent, before or at full retirement age while waiting till 70 to take the rest, though this would require legislative changes.
We conclude that encouraging Social Security lifetime benefit optimization would come at a small price to the government — by our estimate, a roughly six percent increase in long-term costs. And despite the caveats mentioned, we believe the gains to U.S. households are very large.
David Altig is executive vice president and director of research of the Federal Reserve Bank of Atlanta. Laurence Kotlikoff is professor of economics at Boston University. Victor Ye is a research fellow at Stanford University’s HAI Institute.