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Income for Sale

Richard Connor

“SHOULD YOU BUY an annuity from Social Security?” That’s the title of a paper released by Boston College’s Center for Retirement Research (CRR) in May 2012. It’s one of the best articles I’ve ever read about the Social Security claiming decision—and it’s had a big impact on my thinking.

Most of us know what an income annuity is: You hand over a sum of money and, in return, receive a check every month for the rest of your life or for a specified period of time. It’s a way to guarantee a certain level of income. A traditional defined benefit pension is typically paid as an annuity, as is Social Security.

How do you buy an annuity from the Social Security Administration (SSA)? For each year that you delay claiming Social Security, your benefit increases by about 8%. The CRR paper makes the case that delaying Social Security, while using your savings to pay current expenses, is the equivalent of buying an annuity from the SSA. The annuity’s cost is the Social Security payments that you forgo in the meantime. What’s the benefit? That’s equal to the increase in your Social Security check you receive in return for the delay.

The paper provides this example: Assume you’re eligible for a $1,000-a-month Social Security benefit. Waiting a year would provide an approximately 8% increase in that benefit, to $1,080. In the meantime, you would’ve spent $1,000 a month from your savings to cover your living costs.

The upshot: You’ve paid $12,000 during that first year to receive an $80 a month—or $960 a year—increase in your Social Security benefit. The paper says you should think of it just that way: You bought a $960-a-year lifetime annuity from the SSA for $12,000. That’s an 8% return. Even better, that $960 a year will increase annually along with inflation. On top of that, if you’re married, you had the higher lifetime earnings and you predecease your spouse, your benefit will be paid to your husband or wife as a survivor benefit.

The paper provided current rates for inflation-protected annuities for men, women and couples for ages ranging from 62 to 70. Commercial annuity rates vary with age, gender and survivorship benefits. Rates are lower for women, reflecting their longer average longevity. Annuity rates are lower still for plans that provide benefits to a surviving spouse.

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When the paper was published in 2012, available annuity rates for an inflation-protected lifetime annuity ranged from 5.9% for a 69-year-old single male to 4.5% for a 62-year-old single male. Single female rates ranged from 5.3% to 4.1%, and couples’ rates—with 100% paid to the survivor—ranged from 4.3% to 3.4%. All of these were below the 8% available when you buy an annuity from Social Security.

I checked Fidelity Investments’ annuity site to get current rates. The site didn’t offer any inflation-protected annuities—it seems no insurer currently offers them. What about fixed annuities, those that pay the same dollar amount every year? Those ranged from 5.4% to 6.3% for men and from 5.1% to 6.2% for females, again using ages 62 and 69. For couples, the annuity rates ranged from 4.6% to 4.9%.

The site did offer a few options with a guaranteed 2% yearly increase in benefits for couples. For a couple with a 62-year-old male and six-month younger female, the annuity rate was 3.6%. For a 69-year-old male and six-month younger female, the annuity rate was 3.9%.

As you can see, an annuity from the SSA provides a better return than commercially available annuities. This is especially true for couples.

I’ve sent the paper to dozens of friends, colleagues and family members. From the responses I’ve received, I’ve come to realize that the Social Security claiming decision is as much emotional as it is financial. The paper makes a very strong case for delaying Social Security for as long as possible, especially when interest rates are low. But many folks won’t even listen to the argument.

Richard Connor is a semi-retired aerospace engineer with a keen interest in finance. He enjoys a wide variety of other interests, including chasing grandkids, space, sports, travel, winemaking and reading. Follow Rick on Twitter @RConnor609 and check out his earlier articles.

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Andrew Forsythe
Andrew Forsythe
2 days ago

Thanks for this, Rick. It reinforces my decision to wait till 70 to claim my SS benefits.

And it’s mentally a lot easier to have SS as an annuity provider since you don’t have to grapple with the painful choice of forking over a big chunk of cash to an insurance co.

Mr Moderate
Mr Moderate
2 days ago

Thanks, Mr. O’Connor. I understood somehow delaying SSA retirement provided an additional 8% but it wasn’t until you provided that example and explained it in your 5th paragraph that the light finally came on in my brain. Thanks for providing a concrete example!

mytimetotravel
mytimetotravel
2 days ago

“I checked Fidelity Investments’ annuity site to get current rates. The site didn’t offer any inflation-protected annuities—it seems no insurer currently offers them.”

Which makes a SPIA a bad buy. I would love to buy an inflation-indexed SPIA (as an individual, not through an advisor) but have yet to hear of one. Would be even better as a QLAC. (Please don’t suggest Principal, they won’t even give out information on their offerings unless you go though a “financial professional”.)

I did wait until 70 to take SS, but I was able to draw on my ex-husband’s account at FRA, which made the decision easy.

parkslope
parkslope
2 days ago
Reply to  mytimetotravel

You can buy inflation-adjusted annuities but the cost is steep. A better approach is to buy a series of deferred annuities that will increase your stream of income over time.

mytimetotravel
mytimetotravel
2 days ago
Reply to  parkslope

You keep posting that, but you have yet to post a link to an actual product I, as an individual, can actually buy. And I don’t see how a deferred annuity will help with inflation. The amount of income I am buying will not increase.

Roboticus Aquarius
Roboticus Aquarius
2 days ago
Reply to  mytimetotravel

Not sure why such a link is his responsibility.

He’s talking about laddering annuities such that every few years another small additional annuity kicks in. A random example: your main annuity for $100 a month starts in year 1. Then in year 3, an additional annuity kicks in for $10 a month. In year 5 another additional annuity for $10 more per month. This essentially increases your “paycheck” every few years, going from $100 to $110 to $120 over 5 years.

mytimetotravel
mytimetotravel
2 days ago

S/he keeps telling me that there are inflation-indexed annuities available, but has yet to provide a link to one I can actually buy. Note that the author of this article didn’t know of any either.

Buying a non-inflation-indexed annuity at today’s rates, even if deferred, is of no value if we have noticeable inflation.

parkslope
parkslope
1 day ago
Reply to  mytimetotravel

The millions of Americans who are fortunate to be receiving fixed-rate defined benefit pensions would be surprised to know that they are of no value when we have noticeable inflation.

parkslope
parkslope
2 days ago
Reply to  mytimetotravel

The primary risk of most annuity payouts is inflation. If your annuity pays a fixed $3,000 per month for life, and inflation increases 10%, the buying power of your annuity payments decreases to $2,700. In real terms, your benefit decreases in any period in which inflation increases. Because of the decades long low inflation environment in the United States, inflation hasn’t received much attention in regard to annuities. But if, and when, inflation rears its ugly head, the decreased buying power of fixed annuity payments can negatively impact a retiree’s standard of living.
This should not be a reason to avoid using annuities in retirement planning. Annuities are one of the few ways to obtain a retirement income that can’t be outlived. They are a form of do-it-yourself defined-benefit in an economy where there are few defined benefit opportunities. When considering annuities in retirement planning, however, the investor should factor in the inflation risk associated with a fixed annuity payout. Like any risk in retirement planning, there are ways to insure, hedge, offset, mitigate or otherwise lessen the impact of a known risk. Below are some ways to manage the inflation risk of annuities.

  1. Real Annuities. One seemingly easy solution to this issue is to use inflation adjusted annuities instead of the more common fixed annuity payout. Often called “real annuities,” these are still fixed annuities, but they are designed to increase the monthly income payout each year based on a predetermined formula. The increase is usually tied to changes in the consumer price index. While this addresses the inflation risk, the cost of this protection may outweigh the benefit. Research by Morningstar’s director of retirement research, Dr. David Blanchett, suggests that real annuities are “a bad deal.” The concern is that research suggests the cost of a real annuity is expensive compared to a fixed income annuity. You get a lot less for a monthly benefit to possibly get more in the future. It may take 12 to 20 years for the real annuity payout to equal what a comparable non-inflation adjusted fixed annuity would pay. This seemingly uncompetitive payout may be attributable to the fact that with a fixed payout annuity, insurers can invest long term and thereby capture the spread between short and long-term rates. It may be that the insurers socialize their investing with fixed annuities with other high yield products in their portfolio. It may even be that since fixed income annuities are a larger part of the market than real annuities, there is more competitive pressure on these insurers to keep payouts high.

https://www.forbes.com/sites/steveparrish/2019/06/17/taming-the-inflation-risk-in-annuity-payouts/?sh=40e575d9206

Ormode
Ormode
2 days ago

You have to look at your overall situation. If you don’t have enough income and assets, then you might want to wait until you are 70. This will increase your income in later years and provide longevity insurance.
If, however, you are facing a problem with too much income in retirement, then you might want to take SS early. This will help you avoid paying enormous IRMAA, and Medicare tax on your investment income.
In theory, if you live the average lifespan, you should get the same amount of money.

Roboticus Aquarius
Roboticus Aquarius
2 days ago
Reply to  Ormode

This seems to me like allowing the tax “tail” to wag the wealth “dog”? I know that there are places in the tax code where small income increases can cause a lot of additional taxes, but are you saying that some of those inflection points will increase in taxes such that you’re paying more than 100% marginal rate on that income? As long as the marginal rate is under 100% I’d not consider the higher income a ‘problem’.

Last edited 2 days ago by Roboticus Aquarius
Ormode
Ormode
1 day ago

You’re not taking a lower income overall, you’re just spreading it out over more years.

Roboticus Aquarius
Roboticus Aquarius
1 day ago
Reply to  Ormode

Thanks, I missed your final comment above. Theoretically, that’s true.

R Quinn
R Quinn
2 days ago

I think we have been conditioned to think incorrectly about SS. When I managed pension plans there was the normal retirement age and early retirement. You could retire at 60 with a minimum of 20 years of service. Full retirement was 65 with any service. If you worked longer your higher benefit was created by longer service and perhaps higher average earnings, but not age.

The reality is that the normal retirement age for SS is 70 and if a person retires before that they receive an early retirement (actuarial) reduction in benefits. But which approach sounds nicer, you will gain if you work longer or you will lose less of your accrued benefit?

IMO the way SS is communicated, i.e. work longer for a higher benefit, distorts the decision process for many people. Can I afford to retire early and take a reduced pension is the way to look at it.

Last edited 2 days ago by R Quinn
Roboticus Aquarius
Roboticus Aquarius
2 days ago
Reply to  R Quinn

Good advice!

Isn’t there a nuance that applies to anything after your “FRA” (Full Retirement Age)? I seem to remember reading that spousal benefits, of which there are a few permutations, are in some cases based on the lesser of your FRA payout or your actual payout. In other words, if your FRA is 67, for example, and you claim at age 70, aren’t some benefits that your spouse can claim paid as if you claimed at age 67?

R Quinn
R Quinn
2 days ago

You’re right a spousal benefit cannot be more than 50% of the workers benefit at their full retirement age even if their benefit is based on age 70.

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