Chas Craig, BridgeTower Media Newswires
Social Security articles typically belabor the long-term financial health of the scheme and/or provide overly generalized advice regarding the proper time one should begin receiving benefits and the most advantageous method of doing so.
We too are concerned about the long-term viability of Social Security if gone unaddressed. However, the probability of federal actions reducing benefits to current beneficiaries or those nearing retirement is very unlikely for two reasons:
(1) People of that age group are an extremely important voting bloc.
(2) Changes will likely be implemented with a meaningful lag so citizens have time to plan accordingly.
Bottom line, we expect people currently 45 and under will mostly bear the brunt of any reset.
Most importantly then for those nearing retirement is that Social Security is so nuanced that it is dangerous to speak in generalities about the best path via a public forum.
However, unless you just simply need the money to live, we advise approaching Social Security in the way you should most any other financial problem, via a discounted cash flow analysis.
Since we have established that Social Security is too nuanced to speak in generalities, below is a specific example from which we hope some specific rules and, more importantly, a general thought process to approaching this common financial problem can be gleaned.
Client email below:
Dear John & Jane Doe:
The aim of this Social Security analysis is to quantitatively lay out two strategies, both of which should improve upon the status quo, and give some qualitative points for you to consider.
Assumptions and data inputs include:
(1) Based on the Social Security actuary tables (most recently updated in 2014), a 68-year-old male is expected to live another 16 years and a 69-year-old female is expected to live another 17 years. Since you both are in above average health, my analysis assumes both of you live another 20 years.
(2) The full retirement monthly benefits (i.e. that which would have been received if taken at age 66) are $2,200 (John) and $1,000 (Jane).
(3) Inflation runs at 2% annually.
(4) Cash flows are discounted at the prevailing yield for Treasury bonds as the counter party (i.e. the U.S. Government) is the same in each instance.
Relevant Social Security rules include:
(1) Since you were both born between 1943 and 1954, your full retirement age is 66, and the percentage pay outs for various ages are: 62 (75%), 66 (100%), 68 (116%) and 70 (132%).
(2) A spousal benefit does not increase past age 66 in the way that it does for one's own earnings record.
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Option 1
Given that Jane has already taken her Social Security (done at 62) and since John was born before 1/2/1954 and has reached full retirement age, he can choose to receive a spousal benefit associated with Jane's earnings record and delay receiving his own benefit until age 70. Doing this is known as filing a "restricted application" and it is an advantage no longer available to people born after 1/2/1954.
John's ongoing employment is not a consideration here since he is beyond the full retirement age of 66, past which you are no longer subject to reduced benefits associated with an earnings test. John's spousal benefit in the two years before turning 70 would be 1/2 of Jane's current benefit. Upon reaching 70 John would file for his own Social Security and drop the spousal benefit. Also, upon John taking his benefit, Jane would be eligible for a small "top off" via a spousal benefit on John's account.
The net present value of the future cash flows associated with this method is $713k.
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Option 2
John could begin taking his Social Security now and Jane would also be eligible for the previously mentioned "top off" payment.
The net present value of the future cash flows associated with this method is $729k.
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Status Quo
John waits until age 70 to file, at which time Jane takes advantage of the spousal "top off" payment.
The net present value of the future cash flows associated with this method is $704k.
Importantly, while the status quo is sub-optimal, I can't say with certainty that option 2 is superior to option 1 solely because it has a higher net present value. Reason being, the higher value of option 2 is associated with a higher rate of return from a riskier strategy than that of option 1. Just like in all financial assets or business ventures, higher risks should be compensated by higher rates of return.
The risk we are worried about in this analysis is longevity risk, or the risk that you live longer than expected (a high-quality problem by most accounts!).
The break-even (where option 1 is first superior on a net present value basis) occurs in year 30, or when you both would be almost 100 years old.
Another thing to consider is that John's benefit will become Jane's survivor benefit, so waiting until 70 would be ideal in the event John passes sooner than expected.
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Chas Craig is president of Meliora Capital in Tulsa (www.melcapital.com).
Published: Fri, Jun 22, 2018
