Longevity risk and Social Security

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July 31, 2012

Longevity risk and Social Security

Money Matters Donald E. Askey The Daily News of Newburyport Tue Jul 31, 2012, 03:00 AM EDT

How you decide to claim your Social Security benefits will reflect how well you understand the financial risk to you of longevity — the risk of living a lot longer than anybody ever has in your family.

If you are healthy, if you practice healthy living habits and if you are in your 50s or early 60s, there is a high probability that you will live into your 90s. And well into your 90s. Does your financial plan address the risk to you of running out of money if you live to age 100?

If you are going to be realistic about the risk of running out of money in retirement, you need to plan now for your income in that 10th decade of life.

Besides a pension, a defined benefit from your employment, if you have one, your own personal savings, how you manage them, your Social Security benefits and how you elect to take them are all you have to work with.

You can use your personal savings to take discretionary and variable distributions in retirement or you can convert some of those savings into guaranteed and predictable distributions immediately upon retirement or later on a deferred schedule. Setting up guaranteed and predictable distributions to start 10 or 20 years after you start retirement is commonly called longevity insurance, purchased in the private marketplace.

But the best deal in longevity insurance comes from the public market in the form of Social Security. And how and when you elect to initiate those benefits will have an impact on the rest of your life.

Everybody’s situation is different, and everybody who has earned income credited to Social Security qualifies for three age-based levels of benefits and options. The first is at age 62, the second is at “full retirement age” (between 66 and 67 based on your year of birth) and the third is at age 70, when delayed retirement credits cease.

Two workers the same age with the same work history, therefore, could elect to initiate benefits at 62 at the earliest and 70 at the latest. Let’s say their benefits are $1,600 at 62 and $2,700 at age 70 and because both are healthy, each lives till age 93. If one starts at 62 and the second at 70 to collect Social Security, the second will have collected almost $200,000 more by his death than the first. By waiting till age 70 the second got Social Security to protect him with additional coverage — publicly supported longevity insurance.

When you are married, the opportunity to leverage the longevity-insurance option increases. Again, not every married couple is the same, but the best strategy for mitigating longevity risk may be for the higher earner to suspend earned benefits till age 70 and take spousal benefits from full retirement age (between 66 and 67) till age 70. This strategy allows the worker to continue to accumulate annual benefit increases of 8 percent a year till 70 and sets the spouse up for the maximum possible benefit after the higher earner dies.

At full retirement age (between 66 and 67), every married or divorced person can choose to elect earned worker benefits (based on one’s own work history) or spousal benefits. If the person with the higher earnings record chooses the lower spousal benefit from full retirement age to age 70 and then elects the higher earned worker benefit, that higher benefit is preserved irrevocably for the couple until the death of the survivor. No private product offers such protection from the risk of longevity.

Don’t try these calculations on your own at home. And, unfortunately, you cannot depend on Social Security personnel to develop the soundest claiming strategy for you. You may have to turn to somebody experienced in designing Social Security distribution strategies based on the complexities of the rules and multitude of individual situations.

Avoid the temptation to take benefits too early, especially if you are healthy. You could outlive all of your savings. But you will not outlive your Social Security benefit, so you want it to be as high as possible, for the rest of your life.

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Donald E. Askey, a fee-only financial adviser and planner with offices in Newburyport and Boston, can be reached at daskey@oakmontpwm.com.