Social Security Q&A: Your Social Security Benefits Depend On the Specifics
by Laurence Kotlikoff
July 14, 2014
Social Security may be your largest or one of your largest assets. How you manage it, by deciding which benefits to collect and when, can make an absolutely huge difference to your lifetime benefits. And those with the highest past covered earnings have the most to gain from maximizing their Social Security.
I’ve been answering questions and writing columns about Social Security each week for the past two years on PBS NEWSHOUR’s website. The editors at Forbes asked me to post a Q&A each day from those columns. To see all my columns, please go to my software company’s site, www.maximizemysocialsecurity.com, and click More Press below the WSJ quote.
Today’s question involves a hypothetical widow named Sally. Sally is 60. She started working at 22, earning $20,000 a year. She stopped working last year, at which point her salary was $61,814. (I’m assuming it grew smoothly at 5 percent each year.) Her husband, Ben, died last year at age 67. He started working at 20, earning $5,000. His earnings grew smoothly (at 4 percent) and when he retired last year, he was making $24,965. Let’s assume her husband hadn’t collected his Social Security retirement benefit before he passed away.
Sally figures she should take her retirement benefit first, to make sure she gets it before she dies. And once she reaches full retirement age, she’s going to switch to her survivor benefit.
Question: Is Sally maximizing her lifetime benefits?
Answer: No. In fact, this strategy will cost Sally over $200,000 in present value lifetime benefits. The optimal strategy, in this case, is for Sally to collect her survivor benefit immediately and wait till 70 to collect her own retirement benefit. This produces $621,170 in lifetime benefits, compared with $417,162 based on her plan.
What’s Sally’s mistake? She’s placing far too little weight on living to 100, which is her maximum age of life. Yes, the probability of making it that long is very low. But so is the probability of Sally’s house burning down. Yet she still buys homeowners insurance. Social Security provides longevity insurance. When Sally thinks about homeowners insurance, she values it in the worst-case scenario — her house burns down. Here, Sally needs to value her Social Security benefits in the worse-case scenario — she lives to 100. (There will, BTW, be over 600,000 centenarians in the U.S. in 40 years. Just saying!)
Now let’s flip the earnings of Sally and Ben. We’ll have Sally begin work at 25, earning $5,000 and experiencing 4 percent wage growth. And we’ll have Ben start work at 22, earning $10,000 and experiencing 5 percent wage growth. Now Sally’s strategy makes sense. She should take her retirement benefit first — at 62 — and her widow’s benefit at 66. This will produce present value lifetime benefits of $617,209. If she instead takes her survivor benefit at 60 and waits until 70 to collect her retirement benefit, she’ll have $525,391 in lifetime benefits, for a loss of $91,818!
My bottom line? There is no general rule in trying to maximize your Social Security benefits. The precise amounts of what you and your current, ex-, or deceased spouse(s) earned and when you and they earned it makes all the difference in the world to what you should do.