Justifying a Delayed Claiming Age for Social Security

Wade Pfau, Ph.D., CFA

by Wade Pfau, Ph.D., CFA

November 10, 2015

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Originally published at Forbes

With an understanding about how benefits are calculated, the important question to consider becomes how to develop a Social Security claiming strategy. When should you apply for benefits? Disagreement exists on this topic, and I will review arguments from both sides. First, I’ll look at the case for delay.

Social Security as Insurance

Blaise Pascal was a seventeenth century French philosopher whose “Pascal’s Wager” posed the argument that it is best, for self-serving reasons, to believe in God. If God does not exist, then a misplaced belief in God will have relatively minor consequences. However, if God does exist, then the impact of belief in God becomes much more consequential: eternity in heaven for believers and eternity in hell for non-believers. The consequences of the decision weigh toward a belief in God.

Pascal’s Wager, as it relates to Social Security, concerns itself with the consequences of longevity risk. We can think of four general outcomes for Social Security: claim early and experience a short retirement, claim early and experience a long retirement, claim late and experience a short retirement, or claim late and experience a long retirement.

What are the consequences of these different outcomes? It is surely unfortunate to experience a short retirement. In relation to Social Security, claiming early in this scenario would have gotten the most out of the program. But claiming late would have resulted in minimal harm. Less would be obtained from Social Security, but there would have been less pressure on the portfolio anyway, and a decent amount may still remain for heirs. A short retirement is less costly, and so heirs will still receive plenty of leftover assets even if Social Security is delayed.

Consequences become more severe with longer retirements, and this is where the focus of decision-making should be placed. If claiming early, you may be setting up conditions for a permanently reduced standard of living in retirement. A long retirement combined with Social Security delay supports a permanently enhanced lifestyle. Greater emphasis should be placed on what happens in longer retirements, because the financial consequences are more severe, and this scenario is when delaying Social Security will have a clear positive impact.

 Pascal’s Wager for Social Security
Claim Early Claim Late
Short Retirement Worked Out Minimal Harm Done
Long Retirement Permanently
Reduced
Lifestyle
Permanently
Increased
Lifestyle

Pascal’s wager insinuates that Social Security should be viewed as insurance, rather than as an investment. Social Security retirement benefits are inflation-adjusted and government-backed. With lifetime cash flows, they mitigate your longevity, inflation, and market risk. If you are more risk-averse and would prefer to invest more heavily in bonds, which do not provide longevity protection, the insurance value of Social Security becomes even stronger because there would otherwise be less potential for upside growth.

Social Security also provides spousal and survival benefits, as well as benefits for dependent children. Importantly, survival and disability benefits are also available for pre-retirees, providing extra insurance value before retirement actually begins. Any discussion about Social Security as an investment should not forget about this insurance value.

It is a bummer to die early. But regret about Social Security claiming doesn’t exist after death, and when we die is a variable we don’t have much control over beyond doing our best to take care of our health. The real concern and focus is to avoid a situation in which you outlive your assets. A bit of patience with regard to Social Security can help you to better manage your longevity risk.


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