The Cost of Delaying Benefits

Why is common sense so rare?

I just heard yet another “economics expert” on cable television (a business finance talk show) talking about delaying Social Security benefits to increase the beneficiary’s income. Here are the basic terms:

  1. At retirement age of 62, the basic monthly benefit is X. I’ll throw in a number of $500, but it doesn’t matter because we’re analyzing the difference in present values of a future income stream.
  2. Delaying benefits until retirement age of 70, the basic monthly benefit is Y=1.76×X. That is a 76% higher monthly payment compared to the age 62 benefit. Using my example number of X=$500, I calculate Y=$880.
  3. Benefits stop upon death. It doesn’t matter whether a surviving spouse will continue to receive benefits upon primary recipient’s demise, because that merely changes the finite term of the income stream for either option. There is still the same termination date for the income stream that can be applied for either option.

The so-called expert says that delaying benefits until age 70 is a better deal. Really? Let’s check the numbers:

  1. Assume a life span of 18 years (216 months) remaining at age 62. In this example, the income stream is scheduled for termination at age 80.
  2. Assume an annual discount rate of 6.00% on the future income stream. The rate of inflation will change over the term, but let’s assume it averages out to a hurdle rate of 6.00% annually to simplify the Time Value of Money calculations. A “hurdle rate” is the minimum required yield to overcome the devaluing effects of inflation to achieve a net gain above the inflation rate.
  3. Age 62: 216 monthly payments (18 years) of $500 discounted at annual rate 6.00% calculates a present value of (drum roll please) $65,949.
  4. Age 70: 120 monthly payments (10 years) of $880 discounted at annual rate 6.00% ($79,265), then discounted again for 96 monthly payments of $0 to account for the 8 years of delay between age 62 and age 70 calculates a present value of $49,106. A net loss of $16,843 in present value compared to the Age 62 ($65,949) scenario.

This means effectively that the Age 62 income stream benefit discounted at 6.00% is worth $65,949 in today’s present value dollars, while the Age 70 income stream is worth $49,106 in today’s present value dollars. By the way, I would have to live to Age 97 to break even on these two scenarios. Although I plan to live forever or die trying, I’ll continue this example to see how to improve my fortunes in the event of my untimely demise at Age 80.

Suppose I could borrow the present value today as a lump sum and repay it completely with the income stream guaranteed monthly benefit. Let’s analyze what I could do with that lump sum now.

Which lump sum would I rather have starting at Age 62? Of course, I’ll take the larger lump sum. I could invest the borrowed lump sum as a leveraged equity investment in an income property to generate a double digit yield income stream that’s all profit, because my retirement benefit income stream is already paying for the lump sum debt. Why be satisfied with $500 per month when I could generate $747 per month at 12% yield that all goes into my pocket? Or perhaps a 15% yield for $885 per month starting now at Age 62 instead of waiting until Age 70?

If the beneficiary survives beyond the 18 years and continues to receive retirement benefits, then the lump sum debt is fully paid off and the total income stream dramatically increases by adding together the continued retirement benefit income stream and the income property cash flow. Where else can you get a retirement income stream that grows so dramatically as you get older? Social Security “Cost of Living Adjustments” (COLA) are tiny incremental increases based on the Consumer Price Index (CPI) and the government rigs the numbers to make inflation look smaller than it really is for the sake of keeping down the COLA.

Income property indefinitely generates cash flow, so the income stream will extend to any heirs on a stepped-up tax basis (no capital gains tax to the heirs). Social Security and other “defined benefit” retirement schemes stop upon the demise of the beneficiaries.

I would much rather have the $500 monthly income for 18 years compared to $880 per month for 10 years and I must wait 8 years before receiving that higher income. Also, at age 62 I still have several years of productive contribution to society compared to age 70. (I know that active seniors can live well into their 90’s and beyond. I am just trying to explain my point that cash now versus cash later must be compared relative to a discount rate to calculate the present value.)

This same calculation applies to any deferred income stream, like a pension or annuity, that has multiple-choice start dates. In the above example, a simple “Goal Seek…” on the mark-up rate (76%) calculates over 136% mark-up to break-even. That means the Age 70 monthly benefit must be 136% more than the Age 62 monthly benefit ($1,181) just to break even on the discounted present value.

The so-called expert is financially illiterate or is a lying mouth-piece for the federal government that is trying to reduce the burden on the bankrupt Social Security Ponzi scheme. By misleading seniors into shifting their demand for Social Security benefits far into the future, the government hopes they will (a) die before receiving any benefits, or (b) die soon after receiving a few months of benefits, and while the seniors are alive before receiving benefits those seniors will continue to vote for those politicians who are promising to pay later for those votes with higher future benefits.

Financial literacy is critical for you and your family, as well as for the general prosperity of society. Always question so-called “expert” authority figures and verify their calculations to your own satisfaction. I’ve shown my calculations. If you disagree with me, then I’ll be happy to review your calculations.

Life is too short to get rich slowly!