How to “Buy” an Annuity from Social Security
Category: Financial and taxes in retirement
May 29, 2012 — Of course you really can’t buy an annuity from the Social Security Administration – but in a manner of speaking you can do something that has the same effect. Last week we came across this seemingly whacky article from the Center for Retirement Research at Boston College, Should You Buy an Annuity from Social Security”. After reading it we think it turns out to be one of the cleverest ideas we’ve heard for a long time.
Background
The biggest financial challenge for today’s retirees is coming up with enough income to pay for a comfortable retirement. Consider these trends:
– The Bureau of Labor Statistics reported that in 2008 only 20% of workers had a defined benefit (traditional) pension plan, and that percentage is headed downward.
– Only a handful of people have saved enough for retirement. Indeed the Employee Benefit Research Institute found in a recent survey that 56% of all workers have saved less than $25,000 for retirement.
– At a generous 4% return, that $25,000 would only produce $1000 a year in income
– The average social security benefit for a couple in 2012 is $23,928, not a whole lot more than the 2012 poverty level in the 48 contiguous states for a 2 person household, $15,130.
Assumptions
In our previous series on Social Security we stressed how waiting until full retirement age or until age 70 provides a very large benefit vs. claiming before that – if you can afford to delay. This is one part of the “buying an annuity” thesis. Another key part of this idea is that your social security benefit is an inflation protected asset, thanks to annual COLA’s. Your other investments are not generally inflation protected, so once you deduct inflation from any returns you are probably not doing as well as you are from social security. These two facts are at the heart of the CRR’s idea of a social security annuity.
The essence of the “buy an annuity from Social Security” idea
An annuity is a contract where you give up a fixed amount of your savings in exchange for an annual payment for the rest of your life. You generally buy them from insurance companies. The gist of the “buy an annuity from social security” idea is that you delay taking social security, “spending” your savings to replace that social security income. For that “purchase” you receive a higher benefit from social security for waiting (the annuity). By using your savings you will not only be earning a very healthy rate of return from increased SS benefits, but you will be gaining benefits that are inflation-indexed. In effect you are “buying” an annuity from Social Security, and the payment you receive is the inflation protected, extra benefit from delaying your claim.
The CRR site has more details that will explain exactly how this works. We recommend you read the full brief to fully understand the concept, but here are a few bullet points:
– The increase in inflation protected monthly income for delaying social security from age 62 to 70 is 76%. This amazing fact makes crystal clear why delaying is a good idea.
– The annual rate of return from a typical, commercially available inflation protected annuity for a husband (65) and wife (63) is 3.7%.
– If you were to use your savings as your income (and delay taking social security) between the ages of 62 and 70 your annual rate of return would be 5.4%, a full 1.7% higher than you could get from a typical commercially available annuity.
Impact of taxes uncertain, but probably minimal
The CRR brief did not address the impact of taxes on this strategy. Assuming that your only income would be from your savings or from social security, taxation is probably not a factor at those low income levels. If instead of using your regular savings you took a distribution from your IRA or 401k to buy the annuity, you would have to pay taxes on that income. However once again, if that were your only income, the taxes on it would probably be minimal. But as with all financial decisions, consult with a tax professional or financial advisor before acting.
For further reference:
Social Security Part 1: What You Think You Know Might Hurt You
Social Security Part 2: Claiming Strategies for Couples
Should You Buy an Annuity from Social Security”.
Note: Be sure to take our new “What is Your Social Security IQ Quiz“. It will give you a score and detailed explanations to make you a Social Security expert (our best advice, read this article first!).
Comments Anyone? We love to know what you think about this strategy. Please let us know in the Comments section below.
Comments on "How to “Buy” an Annuity from Social Security"
Don in VA says:
Great article; thank you! We have changed our social security plans as a result.
Genie says:
We knew that delaying as long as possible to claim SS was a smart move, but this just adds frosting to the cake! Thanks. :wink:
Jeri says:
Is anyone worried about SS not being there when you finally want to claim it???
Tom in NY and FL says:
The sacrificed income from defering the claiming of SS benefits between 62 until full retirement age of 66 is not compensated for until age 80 or so; if you make it to that age you start "losing" the benefit of not having sacrificed that claiming SS at age 62; I haven't seen projections for waiting until 70 but that would be 4 additional years of drawing down your other sources.
In the mean time you would be rapidly eating up your savings and/or IRA reserves leaving dramatically less available to supplement your admittedly higher SS benefits by waiting until you are 70. Of course in this market, there is no assurance that your IRA or other savings pool will appreciate a whole lot unless you are really lucky. Interest rates are at rock bottom and dividends are correspondingly low, with few exceptions (some REITs). I'm surprised that this article didn't mention the "break-even" points of when claiming SS benefits at 62 vs. higher ages starts hurting you and what the impact of drawing down your other income streams (if you have them) prematurely has on your long term financial prospects.
Editor's Note: See Part 1 link above in For further reference section. The break even point for taking your benefits is 78 -no matter what year you start collecting - age 62 - 70 - it doesn't matter, the lines all cross at 78.
scottp says:
I agree with Jeri. This is a great strategy, but ONLY if you believe that the SS rules will not change. I'm 53 and I am unfortuantely conviced that the 'rules of engagement' will have completely changed by the time I reach 70. Too bad, this would have been a sweet strategy.
Old Nassau says:
"Another key part of this idea is that your social security benefit is an inflation protected asset, thanks to annual COLA’s."
Ummm: not quite. For two years, there were no COLA's - "January 2010 -- 0.0%; January 2011 -- 0.0% (http://www.ssa.gov/cola/automatic-cola.htm). On the one hand, good, because no inflation = no COLA. On the other hand, because COLAs are based on increases in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), in which (or whose) health care costs are far less a concern than for (older) retirees, the CPI-W does not, in my estimation, accurately measure inflation for OLDER FOLKS.
All that said, IF YOU FORESEE NO HEALTH PROBLEMS, delay is still the best investment you can make because of the guaranteed benefit increase.
DaveO says:
The author's source for Table 2 is "Author's calculations" SS hasn't had COLA's >4% since the 70s. Using a more realistic COLA <2% the outcome is hardly as impressive. People who write articles like this always over look the present value of money. This model assumes I will live to age 70. However if I start collecting SS at age 62 I would not break even with the higher payout until age 78. Pay me now not later.
sudbury steve says:
Our fanacial afvisor told us about this last year when we retired. We have already "added" $250 to our SS Annuities. It also protects your family with higher survivor amounts.
Thanks for bringing this to everyones attention.
Mad Monk says:
We've been around and around with this issue in our minds. As long as one has met the earnings base requirements (# quarters/years), it SEEMS that soc sec earns ~8% each year one doesn't claim (even if NOT earning during those years). Our money in savings earns nothing even close to that. Seems like a nice SECURE investment (more than stocks, etc.) to let it ride and actually spend down the low-earning IRAs, plus wife is continuing to work part-time (she is "only" just turned 55). As long as one is frugal, I am coming to believe evn more strongly that retirment can be MUCH better than working in the current environment. Last night, we splurged and met another couple for dinner at Uno's and saw a movie afterwards. The other couple had told us of Uno's 40% 55+ discount on whole meal (+free unlimited coffee) during certain part of the year; then, movie theater has senior discount, making $4 each for the new Marigold Hotel film (HIGHLY recommended!!!!!!!!). Live long and prosper ... I heard that somewhere ;-)
russ says:
Hey I think this is a great idea too....I know I hear a lot of the guys I work with say what if you die...well what if you do....what does it matter I tell them, Dead is Dead...period....you were at least planning on something that would help you and your family, and by the way the increased benefit could help your spouse if you did die and you were the higher earner....No brainer for me...Good luck to all, we will need it when you see what the stock mkt did today...
Donny says:
If I will be getting around $40,000 in a lump sum soon, what would be the best ways to gain interest on my money over 10 years or so. Ive been suggested with annuities etc, what would be the best option to get money on my return?
Ray says:
I will file and suspend my SS benefits when I am 69 and my wife reaches her FRA of 66. She will claim spousal benefits for one year, and I will claim my benefits at 70. This achieves the goals explained in the article, and gives my spouse a lot more income and inflation protection over time, especially since I will likely die 8 years before she does. We are likely to live a long time based on our family history. I read that most people underestimate their longevity by 5 years. We also used a small fraction of our retirement savings to buy a joint-life longevity annuity that starts paying when I reach age 85. The break-even point for our annuity was short (only 3 years for principal, plus some more for opportunity cost). This lowers our risk of running short of money in old age, allowing us to enjoy our retirement (spend more) now.