SOCIAL SECURITY STRATEGIES: OPTIMIZ ING RETIREMENT BENEFITS

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Texas A&M University Financial Planning Workshop

October 28, 2011 William Reichenstein, PhD, CFA Baylor University Principal, Retiree, Inc. and Social Security Solutions, Inc.

OUTLINE

I. Background

II. Strategies for Singles

III. Two Key Lessons for Couples

IV. Delaying Social Security can Lengthen a Financial Portfolio’s Longevity

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I. BACKGROUND

• Potential Changes in Social Security Promises • Primary Insurance Amount • Full Retirement Age

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Potential Changes in Social Security Promises

Proposed reforms and reforms recommended by Center

for Retirement Research and others suggest that changes

to Social Security benefits from current promises will be,

at most, minor for people age 55 or older. Our book and

this presentation are best suited to this audience.

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Primary Insurance Amount

• Primary Insurance Amount (PIA) is the basis of most Social Security Benefits.

• PIA is derived from a worker’s lifetime earnings record. • It is the retirement benefit one would receive if claimed at

the Full Retirement Age.

5 Social Security Solutions, Inc. www.SSanalyzer.com (866) 762-PLAN

Full Retirement Age (own & spousal ben) Year of Birth*

Full Retirement Age (FRA)

Per Month Reduction Benefits If Benefits Begin Prior to Full Retirement Age

Age 62 Benefits as % of PIA

Per Month Delayed Retirement Credit

Age 70 Benefit as % of PIA

1943-54 66 5/9% for 36 mos. + 5/12%/mo.**

75% 2/3% 132%

1955 66 and 2 mos 5/9% for 36 mos. + 5/12%/mo.**

74 1/6% 2/3% 130 2/3%

1956 66 and 4 mos 5/9% for 36 mos. + 5/12%/mo.**

73 1/3% 2/3% 129 1/3%

1957 66 and 6 mos 5/9% for 36 mos. + 5/12%/mo.**

72 ½% 2/3%

128%

1958 66 and 8 mos 5/9% for 36 mos. + 5/12%/mo.**

71 2/3% 2/3%

126 2/3%

1959 66 and 10 mos 5/9% for 36 mos. + 5/12%/mo.**

70 5/6% 2/3%

125 1/3%

1960 or later

67 5/9% for 36 mos. + 5/12%/mo.**

70% 2/3%

124%

*Social Security considers people born on January 1 to have been born in the prior year. **The monthly reduction is 5/9% for the first 36 months prior to Full Retirement Age, and 5/12% for every month after the first 36 months.

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Social Security Solutions, Inc. www.SSanalyzer.com (866) 762-PLAN 7

II. STRATEGIES FOR SINGLES

• Key Lesson • Breakeven Dates Refined • Two Criteria for Selecting Claiming Strategies

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Key Lesson

Lesson 1: If a single individual lives to age 80, the cumulative lifetime benefits will be approximately the same whether benefits begin at 62, 63, 64, or any age through 70. •Today, maximizing present value of benefits is essentially the same thing as maximizing cumulative benefits in today’s dollars. But it is much easier to explain maximizing cumulative benefits in today’s dollars to clients.

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Cumulative Benefits by Starting Age Ages 70 75 80 85 90 95 100

62 $144,000 $234,000 $324,000 $414,000 $504,000 $594,000 $684,000

63 $134,400 $230,400 $326,400 $422,400 $518,400 $614,400 $710,400

64 $124,800 $228,801 $332,801 $436,802 $540,802 $644,802 $748,803

65 $112,000 $223,999 $335,999 $447,998 $559,998 $671,998 $783,997

66 $96,000 $216,000 $336,000 $456,000 $576,000 $696,000 $816,000

67 $77,760 $207,360 $336,960 $466,560 $596,160 $725,760 $855,360

68 $55,680 $194,880 $334,080 $473,280 $612,480 $751,680 $890,880

69 $29,760 $178,560 $327,360 $476,160 $624,960 $773,760 $922,560

70 $0 $158,400 $316,800 $475,200 $633,600 $792,000 $950,400

Primary Insurance Amount is $2,000 with Full Retirement Age of 66. The circled number in each column indicates the highest cumulative lifetime benefit for that age. The standard deviation of the column of numbers is lowest at age 80 (rounded to nearest whole year).

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Breakeven Dates Refined Beginning Dates Breakeven Ages

62 versus 63 78

63 versus 64 76

64 versus 65 78

65 versus 66 80

66 versus 67 79.5

67 versus 68 81.5

68 versus 69 83.5

69 versus 70 85.5

62 versus 66 78

66 versus 70 82.5

62 versus 70 80.5

The “62 versus 63” of 78 means that the breakeven age for delaying beginning benefits from age 62 to 63 is age 78. Therefore, if the individual lives past 78 then cumulative lifetime benefits will be higher by delaying benefits from age 62 to 63. The table assumes a Full Retirement Age of 66.

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Two Criteria for Selecting Claiming Strategy Criterion 1: Which starting date for singles or dates for

couples will maximize expected cumulative lifetime benefits? (Also, which starting date(s) will maximize the present value of cumulative benefits?)

Criterion 2: Which starting date for single or starting dates for couples will minimize longevity risk, that is, the risk that the single retiree will deplete her financial portfolio during her lifetime or the couple will deplete their portfolio during their joint lifetime?

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Cumulative Lifetime Benefits if Begun at 62 (early), 66 (FRA) and 70 (Recommended)

In this example, the difference between early and recommended is $198,000 based on a PIA of $2,000 with a life expectancy of 95.

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Claiming Strategy Affects Portfolio’s Longevity

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$100,000

$200,000

$300,000

$400,000

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$600,000

$700,000

$800,000

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62

70

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68

66 64 62

The larger the Social Security benefit, the less that must be withdrawn from financial portfolio and the longer the portfolio will last. From Meyer and Reichenstein, “Social Security: When to Start Benefits and How to Minimize Longevity Risk,” Journal of Financial Planning, March 2010.

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III. TWO KEY LESSONS FOR COUPLES

• Lessons 2 and 3

• Example Illustrating Lessons 2 and 3

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Lessons 2 and 3

Lesson 2: The relevant life expectancy for the decision of when the spouse with the higher PIA should begin benefits based on his earnings record is the lifetime of the second spouse to die, while the relevant life expectancy for the decision as to when the spouse with the lower PIA should begin benefits based on her record is the lifetime of the first spouse to die. Lesson 3: If at least one spouse lives well beyond the age that the higher earner turns 80, the couple’s cumulative lifetime benefits will usually be highest if he delays benefits based on his record until age 70.

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Inputs for Couple’s Example

• Frances is 58 with a Primary Insurance Amount of $1,600, while Mike, her husband, is 62 with a PIA of $2,000.

• Mike is expected to die at age 80 (i.e., in the month of his 80th birthday) and she is expected to die at age 95.

• For simplicity, we assumed they were each born on January 2 of their birth years, so their benefits will begin in January even if benefit begin at age 62.

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Couples Strategies, Ex. 1 Frances/Mike’s Ages Year Strategy 1 Strategy 2 Difference

(S2 – S1) Wash Gravy

58/62 1 $1500 -$1500 -$1500

59/63 2 1500 -1500 -1500

60/64 3 1500 -1500 -1500

61/65 4 1500 -1500 -1500

62/66 5 1200 + 1500 $1200 + 800 -700 -1500 $800

63/67 6 1200 + 1500 $1200 + 800 -700 -1500 $800

64/68 7 1200 + 1500 $1200 + 800 -700 -1500 $800

65/69 8 1200 + 1500 $1200 + 800 -700 -1500 $800

66/70 9 1200 + 1500 1200 + 2640 1140 1140

67/71 10 1200 + 1500 1200 + 2640 1140 1140

… … … … … … …

75/79 18 1200 + 1500 1200 + 2640 1140 1140

76/ 19 1650 2640 990 990

77/ 20 1650 2640 990 990

78/ 21 1650 2640 990 990

… … … … … … …

94/ 37 1650 2640 990 9940

Cum Lifetime Benefits $901,800 $1,158,720 $257,040 -$7,200 $264,240

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Frances is 58 with a Primary Insurance Amount of $1,600 and Mike is 62 with a PIA of $2,000. He dies at age 80 (i.e., in the month of his 80th birthday) and she dies at 95. The Difference column reflects monthly benefits in Strategy 2 less monthly benefits in Strategy 1.

Explanation of Benefit Amounts

• In Strategy 1, Mike begins his benefits at 62 of $1,500 a month. Four years later, Frances begins her benefits at $1,200 a month. After Mike’s death, Frances receives $1,650 a month, which reflects a little-known rule that says Frances receives Mike’s $1,500 or 82.5% of his PIA.

• In Strategy 2, Frances begins her benefits at 62 of $1,200 and Mike files a restricted application for spousal benefits only of $800, half of her PIA. At 70, Mike switches to his benefits of $2,400 a month. After Mike’s death, Frances receives $2,640 a month.

• Strategy 2 is expected to provide $264,240 more in benefits.

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Lessons from Couples Ex. 1

• “Wash” Column reflects Lesson 1. • “Gravy” Column represents the approximate additional

cumulative lifetime benefits from Strategy 2 compared to Strategy 1.

• Mike's $800 a month in spousal benefits from his FRA through age 69 is called claim-now-and-more-later advantage.

• The additional $990 a month beginning when Mike dies until the second partner dies, in this case Frances, when she turns 95 is called the joint-lives advantage.

• This example illustrates Lessons 2 and 3.

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IV. DELAYING SOCIAL SECURITY CAN LENGTHEN A PORTFOLIO’S LONGEVITY • If we begin with an above-average investment horizon

(e.g., 30 years) then delaying Social Security benefits would lengthen the portfolio’s longevity.

• For clients with modest financial wealth, the additional longevity can be substantial (e.g., over 10 years in some cases). For clients with substantial financial wealth, the additional longevity is much smaller (e.g., perhaps 1 year for someone with $3 million in financial assets).

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Mike & Jen, Age 62 with $1,500,000 of assets They began retirement in January 2010. They are wondering how long their financial portfolio may last if they spend $107,800 after taxes in 2010 and an inflation-adjusted equivalent amount each year thereafter while both spouses are alive, but 75% of that amount after the death of the first spouse at 78. They begin Social Security benefits at age 66 getting $2,500 and $1,500 each month in today’s dollars. They have $1,000,000 in 401(k)s and $500,000 in regular taxable accounts. Strategy 1: Withdraw funds from the 401(k)s first and then the taxable accounts. Strategy 2: Each year, withdraw funds tax efficiently from their 401(k)s and taxable accounts in a fashion that is designed to increase the longevity of their portfolio, and use a partial Roth conversion when appropriate.

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In Strategy 1, the portfolio runs out of money at the end of 2039. In Strategy 2, the portfolio runs out of money in 2047. By withdrawing funds tax efficiently, they were able to extend the portfolio’s longevity by more than seven years. See retireeinc.com then Learning Library then Case Studies.

Cyrus Age 62 with $3,000,000 of Financial Assets

He plans to retire from work this year. He has $3,000,000 in financial assets including $1,900,000 in a 401(k),$100,000 in Roth IRA, $100,000 in a non-qualified annuity, and $900,000 in regular taxable accounts. He wants to know how long his financial portfolio may last if he spends $131,000 after taxes in the first year and an inflation-adjusted equivalent amount each year thereafter.

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Three Withdrawal Strategies • Strategy 1: He begins Social Security at age 62 and withdraws

funds tax inefficiently. • Strategy 2: He begins Social Security at age 70 and withdraws

funds tax inefficiently. • Strategy 3: He begins Social Security at age 70 and withdraws

funds in a tax-efficient manner from his financial portfolio. Each year, he will withdraw funds from his 401(k), Roth IRA, non-qualified annuity and taxable accounts in a fashion that is designed to increase the longevity of his portfolio.

• We assume he maintains a 50% stocks-50% bonds after-tax asset allocation with stocks earning 7% per year and bonds earning 3%. Primary Insurance Amount is $2,000. See www.retireeinc.com then Learning Library then Case Studies for more details.

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In Strategy 1, his portfolio runs out of money at the end of 2037. In Strategy 2, his portfolio runs out of money near the end of 2038. In Strategy 3, it runs out of money part way through 2043. The tax- efficient withdrawal strategy added more than four years to to his portfolio's longevity.

Summary Two Criteria: Individuals and couples should consider two

criteria when deciding when to begin Social Security benefits. They want to 1) maximize expected cumulative lifetime benefits and 2) minimize longevity risk.

Lesson 1: If a single individual lives to age 80, the cumulative lifetime benefits will be approximately the same whether benefits begin at 62, 63, 64, or any age through 70.

Lesson 2:The relevant life expectancy for the decision of when the spouse with the higher PIA should begin benefits based on his earnings record is the lifetime of the second spouse to die, while the relevant life expectancy for the decision as to when the spouse with the lower PIA should begin benefits based on her record is the lifetime of the first spouse to die.

Lesson 3: If at least one spouse lives well beyond the age that the higher earner turns 80, the couple’s cumulative lifetime benefits will usually be highest if he delays benefits based on his record until age 70.

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Summary

• Delaying Social Security benefits can extend the longevity of the financial portfolio. In general, the larger the taxpayer’s financial wealth the smaller is the longevity gain from delaying benefits.

• We have not discussed the complex rules governing spousal benefits. These additional benefits mean that Lesson’s 2 and 3 do not always provide the optimal claiming strategies for a couple.

• We have not had time to discuss the earnings test, children’s benefits, divorcee’s benefits, or how pensions from work not covered by Social Security would affect benefits. These factors sometimes come into play.

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