Social Security provides one of the most valuable retirement income streams available today. Often overlooked, it can serve as an ideal annuity-like income source that effectively manages longevity risk. Let’s explore why Social Security is so valuable and how it fits into your retirement plan.
The Power of Social Security as an Annuity
At its core, Social Security operates much like a life annuity. You pay into the system during your working years, and in retirement, it pays you back for the rest of your life. Unlike commercial annuities, Social Security benefits are inflation-protected and guaranteed by the U.S. government. The value of these features cannot be understated, especially when it comes to managing longevity risk—the risk of outliving your assets.
Commercial annuities are often quite costly, as insurance companies factor in their administrative costs, risk margins, and profits. Social Security, on the other hand, is an efficient way to transform your lifetime earnings into guaranteed income.
Viewing Social Security as an Annuity Purchase
A useful frame for viewing the Social Security claiming decision is as an annuity purchase. As an example, assume that you would receive annual benefits of $21,000 if you started receiving your benefits at age 62, and $37,200 if you waited until age 70 to claim your benefits.
By starting at age 70 instead of 62, the retiree misses eight years of receiving a benefit of $21,000. But starting at 70 provides the retiree a net increase in benefits of $16,200 per year for as long as he or she lives. The eight years of lost benefits could be viewed as a premium payment for a $16,200 inflation-adjusted lifetime income starting at 70.
Calculating the Cost of Delaying Social Security
By not claiming until 70, the eight-year loss of Social Security benefits sums to $168,000, which would also be its present value with a 0 percent real interest rate. We could view that $168,000 as the approximate premium to buy a deferred income annuity with inflation-adjusted annual income of $16,200 beginning at age 70. The implied payout rate on the “annuity” provided by delaying Social Security is 9.64%.
This is quite attractive when compared to commercial annuities. The current marketplace does not even offer an inflation-adjusted income annuity at the time of writing. Social Security is inflation-adjusted. We can only approximate inflation by choosing a fixed cost-of-living adjustment for the annuity, though this would not protect spending power if actual inflation rose higher. As well, the $16,200 difference in benefits is measured in today’s dollars and it would grow with inflation for the next eight years. We are forced to also assume an inflation rate for the next eight years to properly discount the income to be received from a commercial annuity.
Social Security Payouts vs. Commercial Annuities
In January 2023, the best available deal at immediateannuities.com for an eight-year deferred income annuity with a $168,000 premium for a 62-year-old with a 3% cost-of-living adjustment on payments is $17,015 of annual income for men, $15,281 for women, and $12,600 for couples with a 100% survivors benefit that would be the closest match for Social Security survivor benefits to the high earner. With eight years of 3% inflation, the real purchasing power for these spending numbers are $13,432 for males, $12,063 for females, and $9,947 for couples.
These represent payout rates of 8% for men, 7.18% for women, and 5.92% for couples. Each of these three numbers can be compared to the 9.64% payout implied by treating Social Security delay as purchasing an annuity. Delaying your Social Security benefits provides a higher payout rate and stronger inflation protection than commercially available annuities.
Delaying Social Security should be the first step for anyone considering annuities as part of their retirement income plan. Commercial annuities do not beat the implied payout rates on delaying Social Security.
Comparing Social Security to Commercial Annuities
Feature | Social Security | Commercial Annuities |
Inflation Protection | Yes | Optional (at extra cost) |
Government Guarantee | Yes | No (depends on insurer strength) |
Survivor Benefits | Yes | Typically requires additional cost |
Cost and Fees | None beyond payroll taxes | Embedded in premium costs |
The table above highlights some of the core advantages of Social Security over commercial annuities. Social Security benefits automatically adjust for inflation, which means your purchasing power is protected throughout retirement. Some commercial annuities offer inflation protection as an optional add-on, but it typically comes at a steep price.
Longevity Risk and Social Security
Longevity risk is one of the biggest challenges in retirement planning—the risk of living longer than your assets can sustain. Social Security is uniquely positioned to help retirees manage this risk because it provides guaranteed income for life. No matter how long you live, you will continue to receive benefits. This assurance is particularly valuable for those who may be concerned about depleting their retirement savings.
In contrast, managing longevity risk through investments or withdrawals alone can be unpredictable. Market downturns, unexpected expenses, or simply underestimating your life expectancy can all lead to financial stress. Social Security mitigates these uncertainties by providing a stable income floor.
Maximizing Social Security Benefits
To fully leverage Social Security’s value, it’s crucial to strategize your claiming decision. For many, delaying benefits until age 70 can result in significantly higher monthly payments. Every year you delay claiming Social Security after your full retirement age, your benefits increase by roughly 8%. This increase acts as an effective, risk-free return on your future income.
Age to Start Benefits | Monthly Benefit (as % of PIA) |
62 | 70% |
Full Retirement Age | 100% |
70 | 124% |
The table above shows how delaying Social Security can enhance your monthly benefit. If you have other sources of income to draw on, it often makes sense to defer claiming Social Security to maximize the payout you receive over your lifetime.
Conclusion
Social Security is more than just a government program—it’s an essential component of a well-constructed retirement plan. Its guaranteed, inflation-adjusted income can serve as a powerful tool to manage longevity risk and provide financial stability throughout your retirement years. By understanding and maximizing your Social Security benefits, you can significantly improve your retirement security.
Whether you compare it to commercial annuities or consider it in terms of managing risks like inflation and longevity, Social Security stands out as the best annuity money can buy.
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