Financial Advice for Retirement, Social Security, IRAs and Estate Planning

Social Security, Inflation, and Interest Rates

Many people benefit from delaying their Social Security retirement benefits until at least full retirement age. Delaying until age 70 can be an even better deal.

For years I’ve shown people how to calculate the difference using what I call the quick-and-dirty method. The method involves calculating how many years you need to live after delaying benefits to earn lifetime benefits equal to those you would have received had you taken benefits early. In other words, how many years does it take to catch up?

While a good tool, the quick and dirty method doesn’t take into account inflation, changes in interest rates, and taxes. That more accurate estimate requires more steps.

The calculations were made in a white paper published by New York Life Insurance Company, Optimizing Social Security. The paper is available at www.nylinvest-ments.com (ignore the hyphen). After factoring in taxes, inflation, and investment returns, the paper calculates the present value of benefits and the cumulative benefits collected at certain ages. Adding these other factors shows that delaying benefits is more attractive in most cases than the quick-and-dirty method.

For example, suppose Rosie Profits is a 62-year-old deciding whether to take benefits at 62 or 70. Her average career earnings are $60,000, which gives her an annual benefit at full retirement age of $2,460. She’ll receive less if benefits start at 62 and more if benefits begin at 70. The analysis assumes a long-term after-tax investment rate of return of 5% and annual inflation of 2%. She’ll be in the 28% tax bracket.

Beginning benefits at 62 would give her a first year benefit of $1,406. The present value of her benefits to age 88 would be $357,541, and the cumulative benefits received to age 88 would be $952,491. Delaying benefits to 70 gives her a first-year benefit of $2,899. Through age 88 she has a present value of $409,645 and a cumulative benefit received of $1,107,562. That gives her a 15% advantage in net present value and 16% advantage in cumulative benefits by delaying benefits to 70.

After 88 the advantages from delaying benefits compound. At age 94 the present value is 24% ahead, and the cumulative benefits are 25% higher.

The study draws several conclusions.

? The lower the discount rate (or assumed investment return), the higher the gains from deferring. In low interest rate times such as today, the advantage of delaying benefits is higher. But if expected returns, or the discount rate, are higher the advantage of delaying benefits is lower.

? The higher the expected inflation rate, the greater the gain from delaying benefits.

? The longer the life expectancy, the greater the gain from delaying benefits.

? The higher the expected tax rate on earnings, the greater the gain from delaying benefits.

This analysis shows only the benefits for a single person or one who doesn’t consider spousal benefits. Married couples have even more options for optimizing benefits, which we’ll review again in a future visit.

RW July 2015.

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