“SHOULD YOU BUY an annuity from Social Security?” That’s the title of a paper released by Boston College’s Center for Retirement Research (CRR) in May 2012. It’s one of the best articles I’ve ever read about the Social Security claiming decision—and it’s had a big impact on my thinking.
Most of us know what an income annuity is: You hand over a sum of money and, in return, receive a check every month for the rest of your life or for a specified period of time. It’s a way to guarantee a certain level of income. A traditional defined benefit pension is typically paid as an annuity, as is Social Security.
How do you buy an annuity from the Social Security Administration (SSA)? For each year that you delay claiming Social Security, your benefit increases by about 8%. The CRR paper makes the case that delaying Social Security, while using your savings to pay current expenses, is the equivalent of buying an annuity from the SSA. The annuity’s cost is the Social Security payments that you forgo in the meantime. What’s the benefit? That’s equal to the increase in your Social Security check you receive in return for the delay.
The paper provides this example: Assume you’re eligible for a $1,000-a-month Social Security benefit. Waiting a year would provide an approximately 8% increase in that benefit, to $1,080. In the meantime, you would’ve spent $1,000 a month from your savings to cover your living costs.
The upshot: You’ve paid $12,000 during that first year to receive an $80 a month—or $960 a year—increase in your Social Security benefit. The paper says you should think of it just that way: You bought a $960-a-year lifetime annuity from the SSA for $12,000. That’s an 8% return. Even better, that $960 a year will increase annually along with inflation. On top of that, if you’re married, you had the higher lifetime earnings and you predecease your spouse, your benefit will be paid to your husband or wife as a survivor benefit.
The paper provided current rates for inflation-protected annuities for men, women and couples for ages ranging from 62 to 70. Commercial annuity rates vary with age, gender and survivorship benefits. Rates are lower for women, reflecting their longer average longevity. Annuity rates are lower still for plans that provide benefits to a surviving spouse.
When the paper was published in 2012, available annuity rates for an inflation-protected lifetime annuity ranged from 5.9% for a 69-year-old single male to 4.5% for a 62-year-old single male. Single female rates ranged from 5.3% to 4.1%, and couples’ rates—with 100% paid to the survivor—ranged from 4.3% to 3.4%. All of these were below the 8% available when you buy an annuity from Social Security.
I checked Fidelity Investments’ annuity site to get current rates. The site didn’t offer any inflation-protected annuities—it seems no insurer currently offers them. What about fixed annuities, those that pay the same dollar amount every year? Those ranged from 5.4% to 6.3% for men and from 5.1% to 6.2% for females, again using ages 62 and 69. For couples, the annuity rates ranged from 4.6% to 4.9%.
The site did offer a few options with a guaranteed 2% yearly increase in benefits for couples. For a couple with a 62-year-old male and six-month younger female, the annuity rate was 3.6%. For a 69-year-old male and six-month younger female, the annuity rate was 3.9%.
As you can see, an annuity from the SSA provides a better return than commercially available annuities. This is especially true for couples.
I’ve sent the paper to dozens of friends, colleagues and family members. From the responses I’ve received, I’ve come to realize that the Social Security claiming decision is as much emotional as it is financial. The paper makes a very strong case for delaying Social Security for as long as possible, especially when interest rates are low. But many folks won’t even listen to the argument.
Richard Connor is a semi-retired aerospace engineer with a keen interest in finance.