Avoid The Social Security Nightmare That Doomed This Couple
by Laurence Kotlikoff
July 31, 2014
Sally and Arthur Blackstone are a nice, hypothetical upper-middle class New York couple who contributed at the maximum level to Social Security since graduating law school.
Many people think Social Security is a big deal for the poor but not that important for the middle class. Not true. Though Social Security is progressive — higher contributions produce less than proportional increases in benefits — those that earn and contribute the most also stand, in absolute terms, to get the most back from Social Security.
Take Sally and Arthur, who just turned 62. They’re burned out and calling it quits. Their goal is to retire in Austin, Texas, where they grew up. But housing there has gotten expensive and after putting the kids through private schools and college and paying New York City prices for decades, they aren’t particularly flush.
Apart from their small, two-bedroom condo, they have $1.3 million in retirement accounts. That may sound like a lot. But it’s not actually very much when it comes to financing an upper middle-class lifestyle for what may be another 35 years. Sally and Arthur were good savers, but Arthur pulled them out of the market at the bottom in 2008 and has invested everything in money market funds ever since. They are earning no income after inflation on their money and are terrified of putting it back in stocks.
Now, after decades of paying FICA taxes without much attention to what they’d get back from the system, they are greedily eyeing their Social Security benefits. Arthur’s plan is to take benefits this year. He figures they are worth around $1.2 million in present value. But Sally, who could kill Arthur for losing so much money on the market, has a different view. She thinks they should wait until 70 when their retirement benefits will start, after inflation, at a 76 percent higher value. That would bring their lifetime benefits, valued as of now, up to over $1.5 million.
Making an extra $300,000 by doing nothing more than waiting eight years to collect their benefits has prompted Arthur to do his own research. He’s read about a way for one of them to get a free spousal benefit starting at 66 and kick their lifetime benefits up to $1.56 million. Sally’s gone one better and learned that if she and Arthur get divorced between now and age 64, they can both get free spousal benefits starting at 66, and their combined $1.56 million in Social Security wealth will grow to almost $1.62 million.
As they sit over breakfast, debating whether to live in sin or finally get free of one another (it’s been a rocky road since 2008), Arthur realizes they’ve forgotten to value the higher survivor benefits one of them could receive between 66 and 70, were the other to die before 70, as well as the higher child benefits their disabled son would start receiving when they reached full retirement age and one of them were able to file but suspend his or her retirement benefit. They also realized that their son’s child survivor benefit would be higher once the first of them passed away as a result of their waiting until 70 to collect retirement benefits.
Figuring out precisely what these extra benefits are worth is beyond Sally and Arthur’s ken, but they figure optimizing their Social Security decisions over the kitchen table has raised their lifetime benefits by roughly 50 percent — at zero risk.
But lawyers being lawyers, Sally and Arthur decide to check things out with the good folks at the local Social Security office. The Social Security lady with whom they meet, Gladys, is convinced that waiting to collect means losing benefits if you die early. She swore to her husband never to let anyone who crosses her desk make such a mistake. Even though she’s not formally permitted to give advice, she repeatedly asks Sally and Arthur how they would feel were they to die before collecting a single penny of their benefits after contributing taxes for the past 40 years.
Sally and Arthur are won over and sign up for immediate benefits. But one year and one day after the day they went to the Social Security office, they realize they’ve made a huge mistake — had they died without taking their benefits, they would be dead and feeling no pain, including painful regret.
Gladys, the woman from Social Security, was trying to help, but she wasn’t thinking about their retirement benefits the right way. In reality, their past contributions represented insurance premiums to purchase an insurance policy against living longer than average, and the payoff from the policy was their monthly benefit. Giving up eight years of retirement benefits in order to get much higher benefits starting at age 70 simply represented another way to buy more longevity insurance from Uncle Sam. In this case, the eight years of lost retirement benefits represented the premium payments and the 76 percent addition to their retirement benefit starting at 70 represented the larger payout. And this is not to mention the free spousal and extra widow(er) and child benefits they forfeited.
With this realization now clearly in mind, Sally and Arthur rush back to the Social Security office, sit down with Gladys again, and tell her they want to pay back every penny they’ve received in the last year and return to their original collection plan. They bring along confirmation from a software program they’ve run that underscores the huge gain from following their original plan compared to following Gladys’ strategy.
Gladys smiles, shakes her head, and says, “You’re making a mistake in your thinking. Social Security set up the system to be actuarially fair — so that you’d get the same deal on an expected value basis no matter when you take your retirement benefit.”
Arthur screamed, “But we’re not an insurance company! ‘Expected this, expected that’ is relevant to an insurance company, but not to us. We’re only going to die once and the way it’s looking, that will be damn late!”
Gladys smiles again and says, “But, in any case, you’re a day late. You have one year exactly — not a day, nay not an hour, minute, second or nanosecond longer — to repay and start your collection strategy from scratch.”
Arthur, who suffers from hypertension, goes ballistic. Soon, Glady’s manager, Jane, appears. Jane tells Arthur, who is now feeling chest pain, to calm down and stop shouting. “Gladys,” Jane explains, “didn’t advise you what to do. She just laid out your options. You decided what to do. And now you have to live with the consequences. You can’t undo what you’ve done.”
“Does this mean we can’t collect spousal benefits?” asks Sally.
“Well, you can collect them, but they’ll be zero,” replies Jane. “The only option you have to raise your benefits is to wait until 66, your full retirement age, and suspend your retirement benefit and then start it up again at 70 at a 32 percent higher level from where you suspended it.”
“So we’re permanently screwed?” screams Arthur.
“Not if you die young,” replies Gladys, still smiling. “And there’s every chance that could happen.”
Sure enough, Arthur collapses on the spot and the EMTs pronounce him dead. As he’s wheeled past Gladys, she pats his body. “See, aren’t you glad you followed my advice? At least you got one year of benefits.”