Retirement income is critical to any business transition or retirement plan. Social Security income benefits account for 52% of all income for Americans older than 65 and most people are not aware of all the benefits to which they are entitled.
Some readers might think that they have heard enough about Social Security benefits. It seems that many organizations are pounding on the drum about how important it is to delay benefits in order to get the maximum benefit to which you are entitled.
But a new General Accounting Office study says that maybe you haven't been listening. The report draws on Social Security's own research about how much people understand about Social Security benefits.
SPOUSAL BENEFITS
Spousal benefits allow a person to collect a benefit based on the work history of their spouse regardless of whether that person ever worked a day in his or her life. A full 50% of respondents did not know that a Social Security payroll tax-paying history was not required to qualify for spousal benefits. Even more surprising, 52% of respondents didn’t even know that there was such a thing as a spousal benefit.
TAXATION
There is also confusion about taxation. As much as 85% of Social Security benefits could be taxed, depending on one’s total income level, but 42% of respondents did not even know that benefits could be taxed.
The report also shows that human nature is a big part of the "bad choices" people routinely make about when to start Social Security income.
BREAK-EVEN ANALYSIS
When most people ask for help understanding when they should start claiming Social Security they are often presented with a break-even analysis.
This common tool graphs the lifetime benefits received starting at different ages. Since the size of the monthly benefit increases each year you delay starting up to age 70, the maximum lifetime benefit comes from waiting to start income benefits at age 70 and then living longer than average.
Break-even analysis also demonstrates how long it takes for a person who delays claiming to "catch up" to a person who started taking benefits early. If one person starts benefits at 62 and a second person starts benefits at 70, the cumulative lifetime benefit will catch-up at a future break-even age, usually in one’s early eighties.
Human nature comes in because humans have a VERY strong aversion to loss. These graphs show how delayed claiming yields increase total benefits over time. But they also demonstrate how much benefit a person stands to LOSE if they die young. Especially if they die before age 70.
Individuals irrationally fear the potential loss of lifetime benefits due to an early death, no matter how unlikely that scenario is when they view the break-even analysis results. They also view the option of delaying claiming as placing them in a stressful situation of needing to ‘catch up’ to the lifetime benefits they would have collected by claiming early. The net effect is that more people chose earlier filing when presented with the break-even analysis than if they were not.
LONGEVITY RISK
Break -even graphs also appear to fail to explain longevity risk.
Longevity is increasing and represents one of the main financial risks people face in later life. One is four people over 65 is expected to live to at least 90. A 65-year-old couple has a 50% chance that one of the spouses will live till at least 92.
Delaying claiming Social Security provides a crucial ‘longevity insurance’ type of benefit. Delaying claiming insures against financial challenges of longer lives by providing significantly higher lifetime monthly income. This is especially important the older one gets and as the cost of living increases.
Unfortunately, break-even analysis seems to actually de-emphasizes the essential ‘longevity insurance’ feature of delaying claiming. It causes individuals to fixate on perceived short-term losses while ignoring long-term needs.
What makes this even worse is that many individuals do not understand the real probability of living a long life. Two out of five respondents over 45 underestimated average life expectancy by FIVE years.
According to the Social Security mortality table, the average 50 year old American man can expect to live to age 80. An American woman the same age can expect to live to 83. And 60 year olds get 2 additional years on average. Men can expect to live to age 82 and women to age 85.
Furthermore, even if they accurately estimate life expectancy, people tend to anchor onto this lifetime average as a practical life expectancy for planning purposes. They often do not realize that almost 50% of people, by definition, will live beyond this age.
If you have been thinking about when to start claiming your social security benefit, maybe you would like a bit of advice. My office has some great resources for evaluating your best options to maximize your lifetime Social Security income benefit.
If you would like a personalized analysis of how to maximize your own social security benefit, contact my office at rdunn@dunncreekadvisors.com. I love to talk about this stuff. Dunncreek Advisors does not provide legal or tax advice, nor is this article intended to do so.