Academic journal article Financial Services Review

Optimizing the Initiation of Social Security Benefits

Academic journal article Financial Services Review

Optimizing the Initiation of Social Security Benefits

Article excerpt


This research examines the decision couples and individuals face when determining the age at which to begin receiving their Social Security benefits. By comparing a personal required rate of return to the internal rate of return between various retirement ages and various life expectancies, a couple or an individual can better decide when to initiate receipt of Social Security benefits. Early initiation of benefits is the correct course of action for individuals with lower life expectancies. However, delayed initiation of benefits may often be the correct course of action for a single person with a long life expectancy or for a married male who is the higher income-earning spouse. © 2006 Academy of Financial Services. All rights reserved.

Keywords: Social Security; Mortality; Retirement cash flow

1. Introduction

As the "baby boomer" generation nears retirement age, each boomer must decide when is the right time to start drawing Social Security benefits. This study examines how mortality considerations and other factors influence the determination of the optimum financial time to initiate drawing these benefits. Obviously many things can influence retirement and the decision to start drawing benefits, such as personal health, work environment, and various family issues. However, these issues are case-by-case considerations separate from the general rule of how to maximize the financial value of Social Security benefits.

This research focuses only on the retirement cash flows associated with the old age and survivors' insurance program within Social Security. Social Security provides for a host of other benefits such as disability insurance, death benefits, non-spousal survivor benefits, and others. The other benefits increase the attractiveness of the Social Security program to workers, but incorporating these other benefits is outside the scope of this research.

Current law provides for "full retirement age" somewhere from age 65 to 67, depending on one's date of birth. For many baby boomers full retirement age is around 66 years of age (see Table 1 ). Full retirement age benefits are primarily a function of payments into the program while working during the years before initiating the receipt of benefits. By starting to receive Social Security benefits at an age other than the full retirement age, individuals will permanently increase or decrease the monthly benefits they are entitled to receive.

Table 2 reports examples of the level of reduced and augmented Social Security benefits relative to the year of birth and age at date of initiation of benefits. For example, an individual who was born in the 1943 through 1954 period and who starts drawing Social Security benefits at age 62, would receive 75% of his or her full retirement benefits (i.e., that person would receive a 25% permanent reduction in the level of his or her benefits). However, by waiting until age 70 this individual would receive 132% of full retirement age benefits. There is no increase in the level of benefits past the age of 70.

2. Literature review

Because of issues encompassing the financial viability of the Social security trust fund, much uncertainty surrounds the issue of Social Security benefits. However, it is generally advised in the literature (Reichenstein, 1998; Tacchino & Saltzman, 2001) that individuals should make their financial plans on the assumption that Social Security will be present and solvent when they retire.

Most studies that have been done on when to initiate the receipt of benefits use a form of time value of money analysis. In one of the earlier studies Detweiler (1999) treats cash flows one creates by taking Social Security at age 62 (to age 65) as negative cash flows; cash flows from starting Social Security at age 65 and later are treated as positive cash flows. He then uses selected discount rates and calculates the time of death where the net present value of the total cash flows goes to zero. …

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