Should you claim Social Security benefits earlier if your life expectancy is shorter than average? I don't think so.

U.S. News & World Report's Emily Brandon discusses a number of different Social Security claiming strategies. Check out the details here. It's a good summary of the current literature on claiming strategies, which is developing rapidly.

But here's one place I don't entirely agree with Emily. Here's the passage, in which I'm quoted:

Benefit checks increase by about 7 to 8 percent for each year you delay claiming up until age 70. Retirees who sign up at younger ages get smaller payments over a longer period of time, while those who wait get larger checks for their remaining years. "I would argue they would be better off claiming later because then they get a higher benefit and because you are getting more insurance against outliving your assets because Social Security benefits last as long as you live," says Andrew Biggs, a resident scholar at the American Enterprise Institute and a former deputy commissioner of the Social Security Administration. Of course, if you have a reason to believe you won't live a long life, it's best to sign up right away.

It's the last line, which I've italicized, that I question.

Let's say you're part of a group with known lower-than-average life expectancies – say, African American males. You know that while a typical 65 year old might live to age 83, an African American male on average lives to only 80. On average, then, you'll collect benefits for fewer years. But here's the key: you still have a lot of uncertainty regarding how long you'll live and a higher Social Security benefit protects you against that uncertainty. The chart below, which I put together from life tables from the National Center for Health Statistics, shows that average life expectancies have only limited value; the range of outcomes also matters a lot, but people don't think very much about them. For instance, a 65-year old black male has around a 10 percent chance of living beyond age 92 – for those individuals, a higher Social Security benefit would be of great value in holding off poverty in old age. Moreover, given standard economic assumptions regarding the utility of money, such that you'd be willing to give up some income today to prevent even a small chance of falling into poverty in old age, the case for even black males – the stereotypical low life expectancy group – to delay claiming Social Security benefits looks stronger.

The broader point is that the choice you make shouldn't be premised on your life expectancy versus the average; what does it matter how long other people live? What matters is your own life expectancy and the degree of uncertainty surrounding that point estimate. The more uncertain your life expectancy is, regardless of the average value, the more a higher annuity payment will benefit you.

Another issue to consider is benefits for your surviving spouse: even if you know you'll die young, by delaying benefits you guarantee a higher income for your spouse later in life. These issues are a lot more complex than some of the usual claiming strategies portray. People shouldn't think of choosing their claiming age as a game in which they hope to survive to some "break even age" and then "make money" afterwards. Choosing your claiming age is about making sure you have money when you need it the most.

Read more!

A bad story (that I happen to agree with)

Today's Washington Post has a story entitled "Many Retirees Face Prospect of Outliving Savings, Study Says." Here's a quote:

The study, set to be released tomorrow, finds that Americans will have to drastically reduce their standard of living before retirement to live comfortably, or even avoid destitution, later in life. Middle-income Americans entering retirement now will have to reduce their standard of living by an average of 24 percent to minimize their chances of outliving their financial assets, the study found. Workers seven years from retirement will have to cut their spending by even more -- 37 percent.

And here's a quote from University of Maryland economist Peter Morici:

"Most people, if they look at their life expectancy and they think they will live to 90, they are nuts to retire at 60. They're going to be living in poverty at 80," said Peter Morici, an economist at the University of Maryland. "I think it's a wake-up call to baby boomers to get serious about getting their houses in order."

Now, with rising life expectancies and fewer defined benefit pensions, it is more important to think about making your money last. A 65 year old may have an average life expectancy of around 83, but there's a non-trivial chance of living to 90, 95 or beyond. You need to play for those years if you don't want to end up running short.

So what's the problem with the article? The study, undertaken by Ernest & Young, was commissioned by Americans for a Secure Retirement, a group that essentially lobbies on behalf of the insurance industry to get government subsidies for annuities. Now, I think more people should annuitize and subsidies might be a good idea, but there's very little hint in the article that the study might be self-serving. There are plenty of good academic studies, including some that conclude that most American retirees are doing just fine. (For example, this paper which concludes that "Fewer than 20 percent of households have less wealth than their optimal targets, and the wealth deficit of those who are undersaving is generally small.") I'm not sure we need to rely on studies funded by groups with a clear financial incentive.

Second, while it's nice to have a quote from an outside expert, Peter Morici is a trade economist – and I'm sure a fine one – not an expert in retirement issues. There are a lot of readily available experts on broad retirement security – say, Alicia Munnell at Boston College or Olivia Mitchell at the Pension Research Council – and a story would benefit from talking to them.

So again, the story's conclusions are good, but I'm not so keen on how they got there.

Read more!

New paper: Encouraging 401(k) holders to purchase annuities

Here's an interesting new paper from the Retirement Security Project by Bill Gale and Mark Iwry of the Brookings Institution, David John, of The Heritage Foundation and Lina Walker, of the RSP. Here's the summary:

This paper proposes a policy that would increase the role of lifetime income products in future retirees' overall retirement planning. Over the next few decades, a substantial number of workers will retire with larger balances in their retirement accounts and have fewer sources of longevity protection than retirees today. They, therefore, must manage these resources to ensure they last throughout their retirement. Lifetime income products would be beneficial for many because payments are made for life and they mitigate the risk of running out of resources late in life. Despite the benefits of lifetime income, current retirees do not use lifetime income products very much and future retirees are unlikely to do so under current arrangements. The reasons may be that retirees already feel they have sufficient guarantees—for example, from social security benefits—against the risk of outliving their resources. However, evidence suggests also that the market for lifetime income products functions poorly and that people do not understand and are biased against the products.

Our strategy addresses market function by making it easier for a substantial number of retirees to purchase lifetime income plans; the increased volume of sales would reduce prices and make them a better value for the average consumer. Our strategy addresses the role of ignorance and bias by giving retirees an opportunity to "test drive" a lifetime income product, which would help overcome existing biases, reframe their view of lifetime income products and improve their ability to evaluate their retirement distribution option.

Specifically, we propose that a substantial portion of assets in 401(k) and other similar plans be automatically directed (defaulted) into a two-year trial income product when retirees take distributions from their plan, unless they affirmatively choose not to participate. Retirees would receive twenty-four consecutive monthly payments from the automatic trial income plan. At the end of the trial period, retirees may elect an alternative distribution option or, if they do nothing, be defaulted into a permanent income distribution plan. Employers and plan sponsors would be encouraged to offer the trial income plan and would have discretion over some of its structure and implementation. By making the proposal voluntary, we allow opting out by anyone who is not interested in purchasing guaranteed lifetime income. Several important questions would have to be resolved before this strategy could be implemented. The aim of this paper is to map out the first of several steps toward increasing the use of income products in 401(k)-type plans, with the ultimate goal of enabling improved retirement outcomes for workers.

Some quick comments: First, I agree with the overall goal of the paper, since annuities provide valuable protection against outliving your assets but most Americans typically don't purchase them. At the same time, I wonder how pressing a problem under-annuitization is for the typical retiree. Low-income retirees subsist largely on Social Security, and so are almost entirely annuitized, while higher income retirees are, well, higher income and presumably can self-insure a bit better. This isn't to say that they wouldn't benefit from greater access to annuities, particularly as we shift from a DB to a DC pension world, but I'll be interested in finding out more about this.

Read more!

A really good ad

I love this ad. While in the tradition of ads you see in Washington, DC, where you're not exactly sure what they're selling, the statistic that Hallmark sold 85,000 100th birthday cards last year is a great heads-up to people planning for retirement that there's a non-trivial chance of living a long time. (Oh, now I get it -- Allstate sells annuities...). You can download the ad in pdf form here.

For those wanting more details, I've calculated the likelihoods that at least one member of a 65-year old couple will survive to a given age:

Age 70: 99.27%
Age 75: 95.83%
Age 80: 86.87%
Age 85: 69.15%
Age 90: 43.46%
Age 95: 18.74%
Age 100: 4.66%.

This is an area where I and many of those who have favored Social Security personal accounts were -- how shall I put this? -- wrong. While there is no reason account holders couldn't purchase annuities at retirement, one attribute of personal accounts that was often promoted was the ability to "unwind" the Social Security annuity to allow for periodic withdrawals or bequests. Annuities provide very valuable insurance against outliving your assets -- a standard finding is that you'd need around $150,000 in a world without annuities to provide the income security of an annuity costing $100,000. While accounts have a number of other strong points, unwinding the Social Security annuity isn't really one of them.
Read more!