Metrics for choosing when to claim Social Security benefits

Non-investing personal finance issues including insurance, credit, real estate, taxes, employment and legal issues such as trusts and wills
Post Reply
Topic Author
Enkidu
Posts: 207
Joined: Mon Jun 02, 2014 8:48 am

Metrics for choosing when to claim Social Security benefits

Post by Enkidu »

Updated October 28, 2015

Due to changes in the law related to file and suspend and deemed filing in the 2015 budget, the results for married people are no longer accurate and the file is no longer available. The file for singles is not affected. I will consider revising the spreadsheet for married couples based on the new law.




I have posted before on finding the actuarial value of delaying Social Security Benefits http://www.bogleheads.org/forum/viewtop ... 2&t=164870 along with several examples of comparing common Social Security claiming strategies for married couples. http://www.bogleheads.org/forum/viewtop ... 2&t=166471

I developed separate Excel2007 spreadsheets for singles and married couples that compare the cash flows resulting from claiming benefits at different ages, including longevity considerations. You can download the spreadsheet for singles here: Singles or here for married couples:NO Longer available. These are Dropbox links and there is no need to register for anything. The technical details with several examples are described in the links above.

The spreadsheets as originally conceived use the Net Present Value (NPV) and Internal Rate of Return (IRR) of survival weighted benefits to compare the value of annuities claimed at different ages. I revised the spreadsheets to include additional metrics that may be relevant to people who are considering when to claim Social Security benefits. For instance, what is the cost of deferring? How does the cost compare to the NPV? Is a higher NPV always better if it is purchased at a high cost? The IRR goes part way to answer some of these questions, but I think more information about the sources of the benefits and the costs will be helpful in making decisions related to delaying SS benefits.

Here are the metrics included in the updated spreadsheets-

Net Present Value (NPV): The NPV of Survival Weighted Benefits is shown for the two annuities and their difference. The NPVs are also reported for each benefit amount: High, Low, and 82.5% floor for survivors if it applies. Many analysts believe that NPV is the single best metric for evaluating SS claiming decisions. Some analysts report only the benefit combination that yields the highest NPV.

Rate where the Annuities are equal: This is the Internal Rate of Return of the difference in Survival Weighted Benefits. The IRR is also a measure of real return on the forgone income from delaying benefits.

Additional Value of Annuity 2: This is the NPV of the difference in Survival Weighted Benefits. This number is also shown in the NPV section but is highlighted because of it's importance when comparing two claiming strategies

Additional Cost of Annuity 2: The NPV of survival weighted forgone income from delaying benefits. This is the amount of money that you would need today to fund the delay, including the probability that you may die, and discounted at the real interest rate. The practical problem for most people is where to get the funds needed to delay taking benefits. Working longer is one option. Second option is to use other sources of funds such as deferred income in an IRA, 401k or similar account. A third option is to delay benefits for a shorter period.

Value Cost ratio: Additional Value of Annuity 2/Additional Cost of Annuity 2. The higher the better, but must be greater than zero to justify delaying benefits. The Value/Cost ratio can vary significantly for different claiming periods.

Years to Crossover: Sometimes called the payback period. It is the number of years to recover the forgone income at the assumed real interest rate. Most analysts believe that the payback period is the least reliable way to measure results from delaying but it is included for completeness.

Other metrics are certainly conceivable and some have been widely discussed but are not included here. For instance, tax consequences of delaying SS benefits and the potential for Roth IRA conversions in the delay period. Social Security benefits are tax preferred, in that a maximum of 85% of the benefits are taxable and some states don't tax Social Security at all. Below the maximum, SS benefits can increase the taxes on other types of income. The forgone income in the delay period is tax preferred income that is not taken in the delay period with the expectation of higher tax preferred income in the future. Ordinarily, the forgone tax preferred income must be replaced from another source that may be fully taxable: like working, and withdrawals from tax deferred IRAs/ 401Ks; or not taxable at all, like withdrawals from cash accounts, Roth IRAs, and so on. Social Security taxation also depends on State tax laws, which may or may not be favorable. I have not included tax effects in the spreadsheets because of the complexity.

Social Security is sometimes called longevity insurance and some commentators seem to believe that no analysis of the costs and benefits is reasonable: "I hope that I don't collect on my homeowner's insurance, why should I expect to collect on my longevity insurance." Others look only at the benefits ("I get 8% per year increase by delaying") and still others look only at the costs ("The payback period is too long"). What I try to do is compare the costs and benefits of claiming strategies including longevity considerations. Most people will comparison shop for all types of insurance policies, including annuities. Delaying Social Security can cost over a $200,000 in some cases, and significantly reduce income producing assets. It is an important decision and worth taking a hard look at different "longevity insurance policies" using a variety of metrics.

Example 1

A 62 year old male is considering delaying claiming Social Security benefits from 62 to 70. His PIA at Full Retirement Age (66) is $2,400, and he estimates his longevity is Above Average. He also estimates that the current real interest rate from safe investments like TIPs is 0%.

A screen image from the spreadsheet is shown below. Now he can see that the additional value of Annuity 2 is about $54,000 and the IRR is 2.21%, well above assumed real interest rate. The additional cost is $163,647 and the Value/Cost ratio is 0.33. This is not a bad outcome if he has savings that he can tap for this amount.

Image

But what if he is doesn't have the capital, or is not comfortable parting with this much. He uses the spreadsheet to look at other alternatives. The table below shows the results when he only delays from 62 to 64. In this case the additional value of Annuity 2 is $20,862 and the IRR is 3.47%. The cost falls to $42,548, and the Value/Cost ratio rises to 0.49. Filing at 64 rather than at 62 produces a higher lifetime income at a moderate cost. The highest lifetime income is produced by waiting until 70, but at a significantly higher cost.

In addition to checking other delay periods he should also do some sensitivity analysis by choosing lower and higher longevity assumptions.

Image

The graph from the updated spreadsheet shows the difference in Survival Weighted Benefits and the cumulative, discounted Survival Weighted benefits over time for the example above. It should be clear from the chart that the individual is better off after two years, when the SWB becomes positive. Some would say that he is better off immediately because he has raised his safe floor income and therefore can immediately increase his spending to the amount that he expects to receive from SS in two years. The "Crossover" is also clearly shown at 16 years. One problem with only considering the years crossover is that everything after the crossover is given zero weight. In this case, considerable benefits are received after 16 years.

Image


The following graph from the updated spreadsheet shows the relationship between the two annuities and their difference as a function of real interest rates. A key technical point is that the NPVs of the annuities are equal when the real interest rate is equal to the IRR, in this case 3.47%. When real interest rates are less than this it is financially better to delay benefits. When real interest rates are greater than the IRR, it is better to claim at the early date. When the real interest rate is equal to the IRR, the annuities are actuarially neutral.


Image


Example 2

The spreadsheet for married couples is more complex, but the decision process is the same. In Example 2 the ages both 62, Husbands PIA is $2,400 and Wife's is $1,400. Both have Above Average longevity expectations, and use 0% as the real interest rate on safe investments. They compare claiming immediately at 62, with both delaying until 70, with the lower earner claiming spousal benefits at 66, her FRA.

In this case, delaying until 70 yields over $240,000 in additional NPV, and the IRR is 5.5%. The additional cost is over $210,000 and the value cost ratio is 1.14. This looks like a very good deal if they can afford it.

This imagaage shown below also gives the source of the benefits, including the 82.5% benefit floor for survivors that only comes into play at claiming age 62 and 63. The addition of total NPVs for each annuity makes it somewhat easier to compare results from this spreadsheet with other Social Security benefit estimators. However, most estimators ask the user to estimate a date of death, while this estimate uses a longevity estimate.

Image

But what if they don't have the $210,000, or don't feel comfortable pulling down their assets this much? Are there alternatives that produce good results, but are cheaper? Of course!

They compare both claiming at 62 with only the wife claiming at 62. The husband claims spousal at 66, and his full benefit at 70. Now the additional benefit amount is about $204,000, but additional cost falls to about $136,000. The IRR rises to 6.45% and the Value/Cost ratio rises 1.5. Although the NPV is lower than both waiting until 70, the 70/66 - 62 option is less costly, and a better return on foregone costs.
They could also use the spreadsheet to compare the options directly, and as always should do some sensitivity analysis with alternative longevity assumptions.

Image

Comments welcome.
Last edited by Enkidu on Thu Oct 29, 2015 5:06 pm, edited 1 time in total.
Bill M
Posts: 438
Joined: Sun Dec 30, 2012 10:10 pm

Re: Metrics for choosing when to claim Social Security benefits

Post by Bill M »

I certainly agree that picking the right metric is the most critical part of the decision.

If you pick a metric like "most SocSec benefits over my lifetime", there are numerous products and organizations that would love to have your business and tell you the answer.

If you do a more detailed analysis that includes other income sources, other savings, and estimates of expenses, some other metrics are available (all comparisons done by present value):
(1) which strategy minimizes my total lifetime income tax?
(2) which strategy minimizes the drawdown from my savings?
(3) which strategy maximizes the remaining savings balance at age XXX?
And, of course, how do actions like Roth conversions impact the answers? They certainly do.

My claim is that the strategy that maximizes present value of Social Security benefits is not optimal under these other metrics. I know that is true for us, but YMMV.
saladdin
Posts: 535
Joined: Wed May 05, 2010 5:45 pm

Re: Metrics for choosing when to claim Social Security benefits

Post by saladdin »

My only metric is "both parents have had multiple forms of cancer and strokes in their 50's" multiplied by " all 4 grandparents died so early I never met them".

I will take SS one second after midnight the first day I can regardless of any calculation in hopes I can live the remaining few years not working.
Topic Author
Enkidu
Posts: 207
Joined: Mon Jun 02, 2014 8:48 am

Re: Metrics for choosing when to claim Social Security benefits

Post by Enkidu »

Bill M wrote:My claim is that the strategy that maximizes present value of Social Security benefits is not optimal under these other metrics.
That is one reason why I include more metrics when evaluating the Social Security claiming strategies, but I would not want to say that the SS strategy that maximizes NPV is never the best. Choosing when to claim SS benefits is an important part of a larger optimization problem. For the larger problem I like to look at an annual consumption floor, lifetime consumption, and terminal wealth that can be left to heirs. The SS decision affects all of these, and I believe that NPV is not the only criteria that is important when evaluating SS options.
Topic Author
Enkidu
Posts: 207
Joined: Mon Jun 02, 2014 8:48 am

Re: Metrics for choosing when to claim Social Security benefits

Post by Enkidu »

saladdin wrote:My only metric is "both parents have had multiple forms of cancer and strokes in their 50's" multiplied by " all 4 grandparents died so early I never met them".

I will take SS one second after midnight the first day I can regardless of any calculation in hopes I can live the remaining few years not working.
Many people feel the same way based on family history. Single men from the Well Below Average longevity groups probably will not benefit from delaying SS benefits, but data from mortality tables suggest married people, even from populations with longevity that is well below average, may benefit from some delay at the current interest rates.
lawman3966
Posts: 1224
Joined: Sun Aug 10, 2008 12:09 pm
Location: Tacoma WA

Re: Metrics for choosing when to claim Social Security benefits

Post by lawman3966 »

Enkidu wrote:
Bill M wrote:My claim is that the strategy that maximizes present value of Social Security benefits is not optimal under these other metrics.
That is one reason why I include more metrics when evaluating the Social Security claiming strategies, but I would not want to say that the SS strategy that maximizes NPV is never the best. Choosing when to claim SS benefits is an important part of a larger optimization problem. For the larger problem I like to look at an annual consumption floor, lifetime consumption, and terminal wealth that can be left to heirs. The SS decision affects all of these, and I believe that NPV is not the only criteria that is important when evaluating SS options.
In case you're interested, and Math junkies usually are, there are papers by Shoven and Slavov that go into extensive detail on SS claiming strategies.

However, from my personal standpoint, it's being over-analyzed.

At current interest rate levels, and with reasonably good longevity in my family, claiming at 70 has always is actuarially superior to claiming earlier, (though actuarial advantage over claiming at 69 is miniscule). However, even if weren't, I'd still claim at 70 for the longevity insurance aspect. Assuming a break even age of 82, If I live to be 92, I would enjoy the benefit of claiming later for a decade. If I die at 79, I'd have a regret in the abstract, that I could have spent more between the earlier claiming age and age 79.

Another way to express the notion is that a higher SS level provides income flooring that is difficult to obtain from other sources.
Independent
Posts: 551
Joined: Tue Sep 22, 2009 1:09 pm

Re: Metrics for choosing when to claim Social Security benefits

Post by Independent »

Enkidu wrote: Social Security is sometimes called longevity insurance and some commentators seem to believe that no analysis of the costs and benefits is reasonable: "I hope that I don't collect on my homeowner's insurance, why should I expect to collect on my longevity insurance." Others look only at the benefits ("I get 8% per year increase by delaying") and still others look only at the costs ("The payback period is too long"). What I try to do is compare the costs and benefits of claiming strategies including longevity considerations. Most people will comparison shop for all types of insurance policies, including annuities.
I'm more or less in the "longevity insurance" school, but that reflects our finances.

I think "most people comparison shop for all types of insurance" misses the issue. "Defer SS" is about whether or not to buy insurance. "Most people comparison shop" after they have decided to buy insurance, and are simply looking for the best price.

I don't know any potential term life buyers who try to look at mortality tables and calculate the present value of expected death claims vs. the present value of premiums. We all know that the pv(benefits) < pv(premiums). So, if we used that measure, we'd never buy any private insurance.

If I decide I want to buy longevity insurance, it's usually easy to compare deferring SS to buying a private SPIA without the need for any pv calculations. With 2015 interest rates, SS wins easily.

Deciding whether I want longevity insurance is a worthwhile question. Your calculations can be used to inform that decision, but it takes some additional thought. I don't think they are set up specifically for that question, but I haven't looked at all of them.

Of course, it's likely that most people who post here have no interest in or need for longevity insurance. They have so much money that the chance of running out before death is trivial. In that case, they may be looking at maximizing their expected estates. I think this approach is useful for those people.
Topic Author
Enkidu
Posts: 207
Joined: Mon Jun 02, 2014 8:48 am

Re: Metrics for choosing when to claim Social Security benefits

Post by Enkidu »

lawman3966 wrote:In case you're interested, and Math junkies usually are, there are papers by Shoven and Slavov that go into extensive detail on SS claiming strategies.
I use an approach that is similar to Shoven And Slovov. Highly recommend their papers-

When Does it Pay to Delay Social Security? The Impact of Mortality, Interest Rates, and Program Rules, Shoven and Slavov, NBER Working Paper No. 18210, Issued in July, 2012 http://www.nber.org/papers/w18210
"The Decision to Delay Social Security Benefits: Theory and Evidence, Shoven and Slavov NBER Working Paper No. 17866
Issued in February 2012" http://www.nber.org/papers/w17866
Topic Author
Enkidu
Posts: 207
Joined: Mon Jun 02, 2014 8:48 am

Re: Metrics for choosing when to claim Social Security benefits

Post by Enkidu »

Independent wrote:I think "most people comparison shop for all types of insurance" misses the issue. "Defer SS" is about whether or not to buy insurance. "Most people comparison shop" after they have decided to buy insurance, and are simply looking for the best price.
From my perspective the decision is to buy more insurance by delaying or not. Social Security provides longevity insurance no matter when you claim. You can buy more by delaying.
Independent wrote: don't know any potential term life buyers who try to look at mortality tables and calculate the present value of expected death claims vs. the present value of premiums. We all know that the pv(benefits) < pv(premiums). So, if we used that measure, we'd never buy any private insurance.
True, buyers of life insurance and annuities don't usually look at present value calculations, but insurance companies definitely use mortality tables and PV calculations to price their products. And most (all?) Social Security calculators report the NPV of lifetime benefits. I wouldn't want to suggest that the NPV of lifetime benefits is not relevant to the decision about when to claim SS.
Independent wrote:Of course, it's likely that most people who post here have no interest in or need for longevity insurance.
Not sure that I agree with this. There are often lively discussions on the Forum about when to file for Social Security that mention the longevity insurance aspects. I don't assume that everybody reading is rich, but the people most likely to be able to consider delaying SS benefits will have enough assets for delay to be feasible. I think that describes many people on and reading this Forum. Just my opinion.
ubermax
Posts: 1716
Joined: Tue Feb 11, 2014 2:19 pm
Location: Connecticut

Re: Metrics for choosing when to claim Social Security benefits

Post by ubermax »

Enkidu,

In the example you provide in the 2nd to last post under the topic "finding the actuarial value of delaying SS benefits" I get the following in cell BD20 on the "Calculations" tab .

12p70(1-12p50)(38016) + 12p50(1-12p70)(11760) +(38016+11760)( 12p70)(12p50) = $39,637 (13% lower on this one cell ) , this assumes that if the spouse is a widow at age 62 she gets $11,760 ; are you assuming she gets a percentage of the $38,016 at age 62 ?

In the above npx is the probability that a life age x lives n years .
Topic Author
Enkidu
Posts: 207
Joined: Mon Jun 02, 2014 8:48 am

Re: Metrics for choosing when to claim Social Security benefits

Post by Enkidu »

Ubermax,

I will respond to this technical comment in the thread where the example is given. This thread is more about metrics for evaluating when to claim Social Security benefits.
Post Reply