Managing Money in Retirement III: One Annuity You Should Buy

This is the third of a series of posts on retirement withdrawal strategies.  If you haven’t read Managing Money in Retirement I and II, please read them first! 

In the last post, we explored the options for generating a lifetime income, something most retirees would find desirable and reassuring.  Social security fits the bill, but may not be sufficient to cover essential expenses.  Most people today don’t receive pensions, and the other options – bond ladders and annuities – have significant disadvantages (as well as some attractive features).  But there is one source of lifetime income that stands out from the pack.   

An annuity that is a good deal

Most immediate annuities have significant drawbacks – a loss of liquidity, a small but real possibility of non-payment, and a high up-front cost relative to the return.  There is one that doesn’t however: delaying social security until 70, or as close to 70 as you can manage.  You can draw social security as early as age 62, but each year you delay increases your annuity payment by about 8%, until age 70.  (Once you’ve reached age 70, there is no further benefit, so don’t delay any longer than that!) 

Each year you delay your benefits, you forgo a year’s worth of benefits in return for a higher payment in all future years.  Delaying the 8 years from age 62 (early retirement) to 70 gives you a 75% increase in exchange for forgoing 8 years of benefits; delaying from full retirement age (66 moving to 67) to age 70 yields a 28% payoff for 3 1/2 years of benefits forgone.  (See graph below.) 

How is this an annuity?  Your foregone benefits are your up-front payment, while the increase in yearly income is your annuity payout. 

Is delay a good deal?  Let’s see.  The table below shows the options available to someone turning 62 in 2019 who would be eligible for a $1,000 benefit at full retirement age (66 ½). 

Social Security Retirement Options – Person Turning 62 in 2019

Such a person would have the option of filing for benefits anytime between 62 and 70.  Delaying from 62 all the way to 70 would cost our retiree eight years’ worth of $8700 benefits, or $69,600, for an increased benefit of $6,660 per year — a stupendous payout rate of 9.5%!  Delaying from 66 to 70 yields a still outstanding payout rate of 8%.  By comparison, a provider on immediateannuities.com quotes a payout rate of 4.45% for a lifetime plus survivor annuity, with inflation protection, for a 70-year-old couple. 

If you do delay taking Social Security, it takes some time for the higher payments to make up for the forgone earlier income.  The graph below illustrates this, showing the break-even age in your early 80s.   As you mull this over, consider that the joint life expectancy of a 65-year-old couple is 91.  And this is the average – today’s seniors are pretty healthy, and there’s a 50% chance that one of you will live even longer than this.  Social security – especially with the higher benefits that come from deferring your claim – provides a convenient form of insurance against this possibility – often called longevity insurance. 

Delaying your social security benefits is the best deal in town, and it’s backed by the US government.  Many financial planners recommend it.  So lots of people must be taking advantage of this option, right?  Well, not exactly.  Take a look at when people actually claim social security:

Social Security Retirement Claims by Age

The most popular social security claiming age is 62, when over 40% of people put in their claims, permanently reducing their lifetime annuity by 28% of the Full Retirement Age amount, and by 43% of the amount at age 70.  90% of people claim by Full Retirement Age and a miniscule 2 to 4% wait until age 70! 

What’s going on?  The most obvious explanation is that people need the money.  Social Security data support this view.  According to the Social Security Administration, the elderly are highly dependent on Social Security benefits: 48% of married couples and 69% of singles rely on Social Security for 50% or more of their income, while 21% of couples and 44% of singles rely on it for over 90% of their income!  These are sobering numbers.  Clearly there’s a large segment of the population that has few other resources and is highly dependent on this vital program to get by.

Another explanation for early filing is a lack of confidence that Social Security will really pay the future benefits it promises today.  Its fiscal woes are well known, and there are periodic stories – often quite amusing – in which intrepid reporters attempt to track down the Trust Fund to see whether it really exists.  It seems quite unlikely that our political leadership would allow a program that is so important to so many people to slide into bankruptcy.  (Actually, even if nothing is done, Social Security would still be able to pay 75% of its obligations when the Trust Fund runs out in 2035 or so.)  Still – urge Congress to emerge from its dystopian funk soon and fix this problem!

Finally, there’s the desire not to be a sucker and leave money on the table should one die relatively young.  I suggest that you will kick yourself a lot harder if you end up living a long life, needlessly living on a Spartan income. 

I should note that deferring your social security retirement benefits may not be the best decision for all people.  Poor health and a shorter than average life expectancy may be good reasons to consider drawing social security early.  The claiming strategies for couples are complicated, and there may be cases where one partner should file earlier.  In most cases, though, it will pay for the higher-earning member of a couple (at least) to delay until age 70. 

For most people in good health, delaying social security to age 70 is a no-brainer.  It gives you a steady income – and peace of mind – at a very reasonable price.  If you can manage to support yourself during your 60s, this should be a part of your retirement plan.  You should certainly delay Social Security benefits before considering putting money down on a private annuity.

Adding to Your Pension

If you qualify for a pension, there is one other annuity that is worth thinking about.  Public sector pensions for state and local government workers sometimes offer the option of purchasing additional years of credit in the pension system.  This functions much the same way as an annuity: you pay an up-front sum (buying, say, 3 or 5 years’ credit), and the pension fund bumps up your pension as if you worked those extra years. 

While it can be a stretch to come up with the lump sum, the terms these government pensions offer are often much better than you would get with a private annuity.  And unlike Social Security, you don’t have to wait eight years to start getting paid back.  If you qualify for a pension, it is worth inquiring about the possibility of adding to it, and doing a few calculations to see if it would benefit you.

Next – putting it all together in a simple plan that combines the best of the safety first and sustainable withdrawal approaches. 

References

Munnell, Alicia H. and Chen, Anqi.  (2015, May). Trends in Social Security Claiming. Center for Retirement Research, Boston College.  No 15-8. 

Quinn, Jane Bryant.  (2016). How to Make Your Money Last.  New York: Simon and Schuster.

Social Security Administration. (2019, January). When to Start Receiving Retirement Benefits. Publication No. 05-10147.

Social Security Administration. (2018).  Social Security Fact Sheet.