The best insurance policy on Earth: waiting until 70 to take Social Security
For shame, for shame if you are among the millions of Americans making, or soon to make, the most common of all Social Security blunders: using the "break-even" analysis to decide when to take your benefits and, as a result, claiming early, instead of understanding Social Security as the safest insurance policy on Earth to protect you against the financial ravages of old age.
No intention here to castigate those who simply cannot afford to wait, of course. America has become an ever more sharply divided economy over the past several decades, with the bulk of Americans experiencing little or no real income growth and (not coincidentally?) saving far too little.
But for those who can afford to wait — and that would include anyone with retirement accounts that can be drawn down, penalty-free — the break-even mistake will cost you, on average, thousands of dollars a year; the population in aggregate, billions, so long as you include the enormous value of the insurance Social Security is providing. This is the cardinal warning of "Get What's Yours," our "runaway New York Times bestseller," now revised to reflect revisions in the Social Security law that (some claim) the book itself helped catalyze. And yet the average age at which Americans still take their standard benefits is 64, despite the fact that waiting until age 70 produces a monthly paycheck about half again as large.
What is a break-even analysis? Using simple arithmetic, if you were to start drawing your reduced retirement benefit of, say, $10,000 a year at age 64, you'd have taken a cumulative sum of $60,000, inflation adjusted, by age 70. But your "maximum" benefit, earned by waiting until 70, figures to be about 50 percent higher: $15,000 a year — thanks to delayed retirement credits which add roughly 8 percent a year for every year you wait to take benefits, starting at age 62. (It might be higher still if you keep working at age 66 and raise your Social Security earnings base.) So at a minimum, you'd be getting an extra $5,000 a year, starting at age 70. Five thousand a year more for just 12 years and you'd have earned back the $60,000 you'd left on the table in years 64–70. You'd have "broken even" at age 82. (And no, you don't have to factor in inflation, since all Social Security benefits are, to repeat, adjusted for the cost of living.)
Note that if you believe Social Security's own — in my view, conservative — mortality projections as of five years ago (the most recent ones published), life expectancy for a male if he makes it to age 64 is 82.4; for a woman, 85. The punchline: on strictly "break-even" grounds alone, you're better off waiting. Add in the value of the insurance, and the calculation isn't even close.
"But wait," you might be thinking; "I would be earning money on that $60,000 if I invested it myself. That's worth something, isn't it? Shouldn't I be calculating the break-even point, based on a reasonable expectation of the returns I can get on that money if I invested it?"
Yes, market returns matter. But Social Security is providing you with a guaranteed, inflation-protected return for every year you wait that's better than any alternative investment out there. Break-even analysis, whether or not you incorporate that "opportunity cost" (as economists term it), is simply the wrong way to think about the decision, despite the fact that many — indeed, far too many — people are absolutely convinced otherwise, as are many software programs, including "leading" commercial ones. And as recently as 2008, the Social Security Administration told its public claims representatives to use a break-even framework to help potential retirees decide when to begin taking benefits.
WHY BREAKING EVEN IS BREAKING BAD
But here's the main point: Viewing Social Security as an investment is economically blockheaded. The message of "Get What's Yours": Don't do it! Instead, think of Social Security as an insurance policy. By waiting to collect benefits until age 70, you are in effect buying extra insurance — insurance against what is perhaps the greatest danger of retirement: outliving your savings. Yes, you are leaving money on the table. (That's the "cost" of the extra insurance.) But you are "buying" protection against penury in old age.
When it comes to death, your greatest fear should not be dying itself, but the very opposite. It should be the fear of immortality. Or, failing that, fear of an epically long life. That's because if you're the typical American who has saved less than $10,000 on average by the time you're within 10 years of retiring, the longer you live, the greater the danger of your "golden" years turning to lead, weighed down by poverty and its attendant anxieties. According to one survey, more than 20 percent of Americans believe they will die in debt.
If you're old and poor, you will face rejections by rising numbers of doctors who won't take Medicare or Medicaid. Your children may face crippling debt to buy you a long-shot cure that no insurance — public or private — will cover. You won't leave the house without a companion for fear of falling, yet won't be able to afford one (or even an Uber).
Still insist on evaluating an insurance policy as an investment, based on a break-even analysis? Consider your house. Does it make sense to buy homeowner's insurance on a break-even basis? To do so, you would compare the money it costs you in premiums to buy the insurance to the cost to you if your house burns down, multiplied by the vanishingly small chance that it will. If this so-called "expected value" of the policy is less than the premium, the insurance "investment" fails the break-even test. For the purposes of this essay, I performed this exercise with my own home. The cost of the insurance: $1,000 a year. Its expected value? $170 a year. (For numbers nerds, that was a $500,000 total loss times its likelihood per year: .03 percent)
Now, we guarantee that the expected payoff from "investing" in your homeowner's policy is also less than the premium the insurance company charges you. In short, you can't come close to breaking even buying homeowner's insurance. The obvious reason is that the insurance companies charge "loads" to cover administrative and other underwriting costs. Thanks to these loads, the total payoffs from homeowner's insurance, life insurance, car insurance, health insurance, etc., are always far less than the premiums charged. (Why do you think Warren Buffett's main business is insurance?) Look, if you focus solely on the break-even, you should never buy any insurance at all.
But that would be crazy. You don't analyze standard insurance this way because you are focusing, properly so, on the worst-case scenario — your house burns down, your car is totaled, you get cancer.
Very few of us can afford to play the odds of catastrophe. And you're in no better position when it comes to Social Security longevity insurance.
In the longevity sphere, the worst-case scenario is, to reiterate, living too long — living to your maximum possible age of life and, as a result, outliving your savings and income. Social Security provides insurance against this worst-case scenario. This insurance is safe against inflation and against default. It's also dirt cheap. There is no close substitute for it in the market.
OUR EARNEST EFFORT TO HELP YOU KEEP MORE OF WHAT'S YOURS
Now if you're still stubbornly tempted to take Social Security benefits at age 64 and invest them on your own, please consider that you're not liable to beat even the average market rate of return.
Let's assume you're the average investor since, on average, those of you reading this probably are. Well, over the 20 years from 1991 to 2011, the average American investor actually lost money, after accounting for all costs and inflation. The reason would seem to be following the crowd — buying when stocks and bonds are flying high and selling when they tank and sink to new lows. This, of course, is exactly the opposite of investing's golden rule: Buy low, sell high. But on average, we cannot be trusted to do so.
The average American's rate of annual loss is only –0.4 percent; however, you shouldn't subtract anything from that $80,000 you'd have been paid by Social Security for waiting four years. But unless you're sure you can beat the average investor, which probably means you're illegally trading on insider information, you shouldn't add anything, either.
Still tempted? Then let us remind you of the discoveries of behavioral economics over the past several decades, which help explain the fact mentioned earlier: that individual investors, on average, lose money, after you adjust returns for inflation.
The main message of behavioral economics, which is really a branch of psychology: Human beings consistently overestimate their own powers. This bias even has a name: "illusory superiority" or, on public radio, "the Lake Wobegon effect," after Garrison Keillor's famous description of the imaginary Minnesota town where "all the women are strong, all the men are good-looking, and all the children are above average." Documented examples abound.
In a survey of faculty at the University of Nebraska, two-thirds rated themselves in the top 25 percent for teaching ability. Nearly 90 percent of MBA students at Stanford University rated their academic performance in the top half of the class.
This is not a new phenomenon. Back in 1976, 70 percent of students taking the annual SATs thought they were in the top half of their peers with respect to leadership ability. Getting along with others? A full 85 percent put themselves above the median, and — we love this — 25 percent rated themselves in the top 1 percent.
And while "illusory superiority" is a worldwide phenomenon, it's especially acute for those of you contemplating the investment of Social Security money — Americans, that is. A famous survey of drivers half a century ago found that 69 percent of Swedes considered themselves above average in driving skill. Americans? Ninety-three percent! Safe driving? Seventy-seven percent of the Swedes called themselves above average; 88 percent of the Americans.
Twenty-five years later, American self-delusion had hardly budged. Asked to rate themselves by eight different measures, including skill and safety, only one driver in five thought themselves below average.
Applied to the world of investing, the widespread recognition of the consequences of illusory superiority can be expressed in only two words: mutual funds! Mutual fund investment managers — and these are the highly paid "experts" of investing, remember — regularly fall short of where they think they will end up. The results of their actively managed investment funds routinely fail to match even market averages. As a result, low-cost index funds sprang up to purchase large numbers of securities whose performance will match market averages. They do not actively manage their holdings and have no illusions about their superiority. But they have become the dominant standard for retirement plan holdings! If so many of the experts have thrown in the towel on coming out ahead, why should anyone expect Social Security recipients to fare better?
This evidence on overoptimism may come as no surprise, but it should give all of us pause. To repeat, Social Security's delayed retirement credits add 8 percent a year to lifetime benefits between the ages of 66 and 70 — after inflation, though with no compounding. Even if you love taking risks and therefore ignore our point about insurance, you should protect yourself against self-delusion.
In the spirit of the truism that repetition is the soul of understanding: The greatest danger you as a prospective retiree faces is outliving your savings. The best way for millions of people to avoid a miserable financial future is to wait to collect Social Security.