Can incentives change the minds of these early claimants? The Social Security Administration thinks they might. In “Incentivizing Delayed Claiming of Social Security Retirement Benefits Before Reaching the Full Retirement Age,” authors Melissa A. Z. Knoll, a research psychologist with the Consumer Financial Protection Bureau, and Anya Olsen, a social science research analyst with the Office of Retirement Policy, Office of Retirement and Disability Policy, Social Security Administration, take a look at the psychological and behavioral research, and explore some ideas to change the current incentive structure to encourage people to delay taking benefits before the full retirement age.
Nearly half of retired workers claim retirement benefits as early as possible, and almost all claim at some point before their full retirement age. Because Americans are living longer but retiring earlier, often with inadequate savings, the timing of benefit claiming can be crucial to financial well-being in retirement. Claiming benefits before the full retirement age results in permanently reduced benefits, so many researchers argue that delaying claiming is often the best decision economically. In fact, delaying the start of benefits is now recognized as an important way to enhance retirement security.
It would follow, the authors say, that delaying benefit claiming can aid in the financial security of older Americans, and they cite the National Commission on Fiscal Responsibility and Reform (2010)—also known as the Simpson-Bowles Commission—as urging the Social Security Administration (SSA) to provide information to the public “with an eye toward encouraging delayed retirement” and to do so by considering “behavioral economics approaches.”
Changing Reductions in Benefits
SSA’s current structure to incentivize delayed retirement benefit claiming involves decreasing monthly benefits if they are claimed before the full retirement age and increasing monthly benefits if they are claimed after it; however, the size of the annual increases in benefits after the full retirement age are larger than the size of the annual decreases in the months before it. That incentive structure results in a number of interesting distributional outcomes and presents an opportunity to introduce policy changes that may affect those outcomes, the researchers say.
They aim to shift that reward structure so that individuals are more incentivized to delay claiming in the months and years before reaching their full retirement age.
The paper notes that individuals who delay claiming after their full retirement age receive an 8% annual increase to their unreduced monthly benefit through delayed retirement credits. In comparison, individuals who wait to claim until at least three years before their full retirement age receive an approximate 6.7% reduction to their unreduced monthly benefit for each year until they reach their full retirement age, while claiming one year earlier, from age 63 to 62, results in an additional 5% benefit reduction.
An individual might not view this 5% benefit change as large enough to encourage them to claim benefits beyond age 62, the researchers note, and the prospect of earning an 8% increase in benefits through delayed retirement credits for delaying benefit claiming after reaching the full retirement age may be too far in the future for it to be a realistic incentive for the 40% of both men and women who currently claim at the early eligibility age. Psychological research has shown that individuals tend to display a present bias, or a tendency to overweigh the value of rewards they can receive immediately.
Increasing the benefit for delayed claiming before the full retirement age would make the monthly change (and therefore, annual change) in benefits from age 62 to 63 (and from age 63 to 64 for those with a full retirement age of 67) larger than in subsequent years. The paper says it is important to note that making the size of the increase larger for each month an individual delays claiming past age 62 is akin to increasing the size of the monthly reduction in benefits over the same period.
However, under this incentive, the total reduction for claiming before the full retirement age would be the same as that under current law (that is, about 25% for individuals with a full retirement age of 66 who claim at age 62 and about 30% for those with an full retirement age of 67 who claim at age 62). Making the suggested changes therefore would not penalize those who cannot delay benefit claiming beyond age 62 (for example, those who become disabled or face a work limitation, are laid off and have few job prospects, or have to care for a disabled spouse or other family member) because the total reduction stays the same.
Offering a Lump Sum
Another idea for incentivizing a delay in claiming Social Security benefits presented by the researchers is based on the fact that Social Security is essentially an inflation-adjusted annuity, and although economic theory suggests that individuals, particularly those who are risk averse, should value an annuity's protection against longevity risk, annuities are notoriously unpopular. In response to people's apparent reluctance to purchase annuities, researchers have explored individuals' preferences for annuities, compared with lump-sum payments; that is, whether individuals would be willing to give up a portion or all of a steady lifetime income stream in order to receive a lump-sum payout.
Research typically finds a strong preference for the lump-sum option. For example, lottery winners tend to prefer a smaller lump-sum payout to a larger annuity option. In addition, some researchers have found that providing lump-sum bonuses to Navy personnel increased reenlistment, as compared with installment bonuses.
Other researchers have explored individuals' preference for a lump-sum payment specifically in the context of Social Security. In their lifecycle model, research in 2013 found that the average retirement age for individuals age 60 rose by 1.4 years when a lump-sum option was introduced for delayed retirement credits.
In 1999, two researchers asked study participants to choose an increase in yearly payments for delaying claiming, from age 65 to 68, or to take a lower yearly payment, coupled with a one-time bonus payment, to be received upon claiming benefits at age 68. Three-quarters of participants said they’d prefer the option with the one-time bonus, while only one-quarter chose the increased yearly benefit. When participants were asked which option they thought the “average American worker” would prefer, 80% indicated that the one-time bonus payment would be a better incentive to delay claiming than the higher yearly benefit.
Based on this research, the authors suggest a possible incentive would be to offer a lump-sum payment to individuals who delay claiming until after age 62. This could be accomplished in two ways: (1) Individuals could receive a lump-sum payout in exchange for some of their monthly benefit increases, or (2) they could receive a lump-sum bonus in addition to their monthly benefit increases.
Bonuses for Continued Working
Individuals are less likely to claim benefits if they are working, so encouraging them to delay claiming may be akin to encouraging their continued workforce participation. Knoll and Olsen suggest that a successful incentive may be one that encourages prolonged workforce participation.
As delayed retirement credits were originally intended to reward individuals who continued to work past full retirement age, there is a precedent for offering increased benefits for increased work. As well as the increased Social Security retirement benefits, encouraging people to work longer could enhance retirement security through other means as well, such as giving them more time to accumulate personal retirement savings.
One way to incentivize work past the early eligibility age, and potentially encouraging individuals to delay claiming past that age, would be to offer intermittent bonuses tied to workforce participation. For example, individuals who continue to work and do not claim benefits after the early eligibility age could receive a bonus at each yearly interval (month 12, 24, 36, and so forth) until reaching full retirement age.
Behavioral economics and psychological research suggest that remitting the bonus as individuals reach each yearly milestone, rather than rolling it into the future benefit, could be particularly effective. Again, because of present bias, knowing that a tangible cash benefit will become available in a few months (once wages are reported) may lead individuals considering leaving the workforce and claiming benefits to delay doing so.
The bonuses would be most effective if each increased in size through the full retirement age, as individuals prefer increasing sequences of income rather than constant sequences, the research suggests. Establishing the optimal size of the bonus could be challenging, the report’s authors admit, but say it would be reasonable to base it on a percentage of annual earnings, which are reported to SSA each year, or on a percentage of his or her unreduced monthly benefit.
Finally, Kroll and Olsen note that recent research has shown lotteries can successfully incentivize low-income individuals to engage in savings behavior. Lotteries take advantage of individuals' tendency to overweigh very small probabilities, which leads to the lottery being overvalued. As such, lotteries can potentially create a more appealing incentive than fixed or guaranteed payouts.
The researchers suggest a lottery system could be created in which individuals who continue to work past age 62 and have not yet claimed benefits would be entered into an annual lottery for the chance to win a cash prize. Under that system, only non-beneficiaries who have earned income in the previous year would be entered into the lottery.
A winner would be drawn annually, because earned income is tracked on an annual basis. In order to ensure that the size of the cash prize is large enough to create a worthwhile incentive to delay benefit claiming, the prize could be a percentage of the individual's income in the previous year. Although this proposal encourages delayed claiming through increased workforce participation, a lottery could also be implemented that is directly linked to an individual's choice to not claim benefits. That is, any eligible individual who does not claim benefits in a given year could be entered into the lottery, regardless of whether he or she had earned income in the previous year.
More detailed information, including a link to “Incentivizing Delayed Claiming of Social Security Retirement Benefits Before Reaching the Full Retirement Age,” with its supporting research and tables, is available at the Social Security Administration’s website.