Can Social Security Be a Silver Bullet?

Employers can quickly boost outcomes in their defined contribution (DC) retirement plans by improving participants’ Social Security withdrawal behaviors, a new analysis suggests.

In a new report, Mercer and the Stanford Center on Longevity suggest retirement plan participants make a variety of common and costly mistakes when it comes to optimizing their retirement readiness. But one of the most widespread problems is a lack of awareness around how to most effectively time the start of Social Security payments.

The Mercer/Stanford analysis cites recent data from the Social Security Administration to show that the Social Security program provides 50% or more of all retirement income for two-thirds of U.S. retirees, and 90% or more of all retirement income for one-third of all retirees. With such a significant dependence on Social Security benefits, low- and middle-income workers who optimize those benefits can significantly improve their financial security in retirement, according to the report.  

While there is unending minutia involved in the difficult calculation of what one’s monthly Social Security benefit may actually be, the main hurdle to increasing the benefit may also be relatively simple to overcome (see “It Is Difficult to Factor Social Security Into Retirement Planning”). Mercer and Stanford researchers suggest the overwhelming problem is that people simply draw Social Security too early—roughly half of all Americans now start Social Security benefits at age 62. As the report explains, this is the earliest possible age at which one can take Social Security, when the retiree will get the lowest amount of retirement income on a monthly basis.

This claiming behavior is suboptimal for people in average or above-average health, the report explains. For these people, retirement security can be enhanced substantially by just delaying the start of Social Security income. For example, delaying the start of benefits from age 62 to age 66 can increase annual Social Security income by 33%, the report says.

Near-retirees may be hesitant to defer income that can be accessed today, but the report suggests delaying to age 70 can increase annual Social Security income by as much as 76%, more than making up for the delay. Of course the ability to delay federal retirement dollars depends on the individual having sufficient savings from which to draw down or other sources of income, the report notes.

John Shoven, director of the Stanford Institute for Economic Policy Research, explains that it may be advantageous for U.S. workers to delay Social Security payments to age 70 even at the cost of depleting personal retirement savings in the early years of retirement. 

As Shoven explains, currently most Americans use retirement savings to supplement their social security income and start withdrawing from savings upon retirement—a method he describes as the “parallel” strategy. Instead of this, he advocates using a “series” strategy, in which retirees first draw down personal retirement savings to pay for living expenses and delay the start of Social Security benefits until age 70. In effect, retirees will use their retirement savings to “buy” a higher annuity from Social Security. This method is likely to result in higher amounts of lifetime income for retirees, Shoven says.

In today’s market, the effective “Social Security annuity purchase rate” is a much more favorable rate than the cost of annuities purchased from private insurance companies, Shoven adds. The reason is that Social Security’s delayed retirement credits were developed when interest rates were higher and life expectancies were lower compared with today. As a result, Social Security’s delayed retirement credits are more than fair actuarially for someone in good health, he explains.

Shoven says both single retirees and couples alike can increase their retirement incomes by several hundred dollars per month at age 70 if they delay Social Security benefits for the primary wage earner. The increase in retirement income from deploying this strategy translates to anywhere from $1,000 to $1,400 per month by age 90, he says. In some hypothetical examples, the gain in the expected value of total retirement income was $200,000.

A full summary of the Social Security research from Mercer and the Stanford Center on Longevity is available here. Mercer and Stanford researchers also recently collaborated on research examining participant statement best practices, available here.