Social Security: Insurance or investment?
Social Security retirement benefits can be claimed beginning at age 62. Once claimed, the retirement benefit is a monthly payment that will last the rest of your life. The payment is adjusted annually for inflation, and payments are taxed more favorably than other kinds of income – in Nebraska, Social Security benefits are not taxed at the state level beginning in 2024.
Every month you delay claiming your benefit after age 62, your benefit will increase permanently at a rate of between 5-8% per year. This decision on when to claim is one of the biggest decisions to make in retirement and is influenced primarily by whether you view Social Security as an investment or as an insurance policy.
Social Security has characteristics of can be thought of as an investment or as an insurance policy, and the way you think about it will influence how and when you claim your benefits.
Let me explain the two belief systems:
Social Security as an investment
Social Security is another investment account with which to generate positive yields. The payments made while working must be recouped with profit, and if one fails to recoup these payments (say, if one dies early), then the investment was unprofitable. Under this belief system, the best strategy is to claim Social Security at age 62 so that you can break even as quickly as possible. If the benefit is more than one needs, the remainder can be invested in the stock market. Each monthly payment is like a dividend, and delaying claiming is akin to forgoing those dividends.
Social Security as insurance
Did you know? The formal name of Social Security retirement benefits is “Old-Age Insurance”.
Social Security is a way to mitigate the risk of outliving your money. Once you claim, your monthly payment continues for the rest of your life and is adjusted annually for inflation; this is known as longevity insurance. Each payment you made into the system while working is considered an insurance premium. When viewed through this lens, the optimal strategy is to delay claiming – thus permanently increasing the monthly benefit - until age 70. Each monthly payment forgone is like an additional premium payment – one that increases the amount of your future benefits.
When discussing Social Security with clients, I often hear things like “I don’t want to die before I get my money back, so I will claim as soon as possible!”, which is quite rational if you subscribe to the investment framework. However, I personally believe in the insurance framework.
The auto insurance analogy
“No one wants to “break even” with their auto insurer.”
Every time we drive a car, there is a risk that we will cause damage to our own car or to someone else’s car or property. The expense of this would be difficult to bear on our own, and the chances of it happening are relatively rare; thus, we transfer the risk to insurers (e.g. State Farm) who agree to pay on accident claims in exchange for a regular premium. Because insurers collect premiums from millions of drivers, the premium can be set at levels that are digestible for us (notwithstanding the steep premium increases that occurred this year).
Most people pay for auto insurance, yet I’ve never met anyone who is upset when she doesn’t get in a car accident, and thus doesn’t “get her money back”. When Social Security is viewed as another form of insurance - insurance against the risk of outliving your money – the desire to “break even” and “get your money back” disappears.
Bonus for married couples
Married couples have an added incentive to delay claiming Social Security benefits. When one spouse dies, the surviving spouse receives the higher of the two spouse’s benefits. Picture a 62-year-old couple - there is a 70% chance that at least one of them will live to age 85. This provides a good reason for at least one of the spouses (typically the higher earner) to delay claiming as long as possible.
How to make the decision
Many Americans don’t have enough saved to afford delaying Social Security benefits. Some people have enough but they don’t know it. If you are unsure, it’s a good idea to speak with a professional who can help you. The best financial professionals will give you a free consultation and will give you a rough idea of the options available to you
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First, you must get clear on your Social Security benefits. Download a statement on SSA.gov to see your projected Retirement benefits.
Next, consider your longevity. Social Security benefits are calculated without consideration of your medical history or sex, so healthy individuals and women will likely have more compelling reasons to delay claiming in exchange for a higher lifetime benefit.
You can always use an online calculator such as OpenSocialSecurity.com and input your data but remember that a calculator will solve for one thing (Net Present Value of your benefits) and does not account for all the other factors in your life such as health and alternative sources of income.
Finally, consider what you are trying to “solve” for. If you want the highest possible lifetime benefit, you should probably delay as long as possible. But if you want the highest possible income in your 60’s and 70’s – to make the most of life while you still have your youth – you might consider collecting benefits immediately, while being aware that your benefit in your 80’s and 90’s will be smaller than if you had delayed. There are no perfect solutions, only tradeoffs.
Conclusion
In the end, the decision you make will be personal. Don’t feel pressured by any of your friends or relatives to make a decision you don’t feel comfortable with. Consider whether you view Social Security as an investment or an insurance policy; I gave you my opinion, but there are people smarter than I who believe in the “investment” framework.
In twenty years, with the benefit of hindsight, you will be able to tell what the correct decision is. All we can do now is make the best decision with the information we have.
And remember that even if you decide you want to wait until age 70, you don’t have to stick with that decision. Social Security benefits can be claimed at the beginning of each month, and you may wake up one day and decide you are tired of waiting. In fact, part of the financial planning process is constantly revisiting these decisions considering new information and changes in attitudes as we age.
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