A brief from the Center for Retirement Research at Boston College contends when workers do so, they are, in effect, buying an annuity from Social Security. The savings they use to pay monthly expenses while they wait is the price, and the increase in monthly benefit gained from waiting is the so-called annuity income it buys.
For example, according to the report, a retiree could claim $12,000 a year at age 65 and $12,860 at age 66—an additional $860 a year. If he delays claiming for a year and uses $12,860 from savings to pay the bills that year, $12,860 is the price of the extra $860 annuity income. The annuity rate—the additional annuity income as a percent of the purchase price—is 6.7% ($860/$12,860).
Buying an annuity from Social Security by delaying benefits is generally more attractive than buying a commercial annuity for several reasons, the brief contends. The annuity a retiree purchases from Social Security is the increase in benefits for claiming at an older age. These increases are designed to be actuarially fair—so “no additional cost to the system arises” due to participants claiming at different ages. Commercial annuities, by contrast, cannot be “actuarially fair.” Insurance companies have marketing, management, and risk-bearing costs that must be added to the “actuarial” price—the expected present value of the income the annuity provides.
More important, Social Security benefit adjustments are based on the life expectancy of the average individual. As individuals who purchase commercial annuities tend to have above-average life expectancy, the cost of the yearly income these annuities provide is higher.
According to the brief, buying an annuity from Social Security is especially attractive when interest rates are low, as they are today. Living on the interest today is essentially impossible, as interest rates on safe assets are currently less than the rate of inflation. Drawing an income from a portfolio invested in stocks and bonds is also less attractive, as bond interest rates are low and any increase would reduce the value of the bonds retirees hold. Commercial annuities funded by bonds also provide much less income than they would in “normal” times. In contrast, the additional income available by claiming Social Security later is not affected by current interest rates.
The brief can be downloaded here.