New paper: A guide to starting Social Security benefits

Richard L. Kaplan of the University of Illinois College of Law has a new paper in the Journal of Retirement Planning, July-August, 2008 entitled "A Guide to Starting Social Security Benefits," which focuses on the decisions facing an individual who is considering claiming retirement benefits. It's a good paper overall, but (like many articles on Social Security written by law professors) it has a great deal of detail but could benefit from greater context.

For instance, Kaplan correctly points out that the Social Security formula is neutral with regard to claiming age, meaning that the average person will collect just about the same amount (in present value) regardless of when he claims. But the decision is framed in terms of a "gamble" over whether an individual who delays claiming will live long enough to break even:

Early benefits are smaller in amount, but will be received for more years, all things being equal, while delayed benefits are larger in amount, but will be received for fewer years, once again all things being equal. The question then becomes what the person estimates will be his or her life expectancy. To put this issue in the starkest terms, getting less now in exchange for more later makes sense only if there is, in fact, a "later." Thus, the question inevitably turns at the outset on such factors as one's personal medical history, including that of one's natural parents, if known.

An alternate, and equally correct, framing devise is to view the Social Security benefit as insurance against outliving your assets. Even people who believe they will live less shorter than the average nevertheless have significant uncertainty regarding their actual age of death. By delaying claiming, you are effectively "buying" more insurance against longevity risk. Put in these terms, more individuals may choose to delay claiming past 62 or 63, the most common ages for Americans to retire.

Likewise, while Kaplan does not describe the retirement earnings test incorrectly, it is framed as an onerous "tax" that most people would seek to avoid:

Any Social Security recipient who has not yet attained the applicable full retirement age faces onerous retirement earnings test that substantially reduces the economic rewards from working. This provision has the same economic impact as a 50 percent marginal tax rate on the affected earnings. Those earnings, moreover, are subject to a federal income tax on income generally of at least 15 percent in addition to Social Security's effective 15.3 percent payroll tax on wages and self-employment income, a combined effective marginal tax rate of over 80 percent and possibly even more, depending upon a retiree's other sources of income. In fact, additional income of $19,940 in 2008 would push this taxpayer into the 25 percent federal income tax bracket, raising that person's effective marginal tax rate to 90.3 percent.27 State income taxes would raise this effective marginal tax rate still higher.

The problem is that the earnings test doesn't have "the same economic impact as a 50 percent marginal tax rate on the affected earnings." If benefits are increased at the normal retirement age to account for the earnings test (as I discuss in this paper), then the earnings test is no more a tax than is, say, the automatic deduction of contributions to a 401(k) plan. Yet if this isn't made clear, the typical person will misunderstand the provision and potentially mis-react to it.

All that said, an interesting paper and a good resource for someone looking to understand the questions a potential claimant should consider.