For years the Social Security Administration urged retirees to take Social Security as soon as possible, even though doing so meant permanently receiving lower benefits. Here’s what they’ve said: “From an actuarial perspective, it doesn’t matter when you start collecting. But you may die early and regret (hopefully, in heaven) having waited, so don’t take the chance of dying before collecting. Take your benefits early.”

This advice and logic was as bad as it got. As far as we know no one has any regrets in heaven or needs any money.

Fortunately, thanks, in part, to discussions we've had with their Chief Actuary, Social Security is no longer twisting people’s arms to take benefits early. The reason to wait is that by doing so you are effectively buying more longevity insurance – more insurance against living longer than expected. (But, as described below, waiting to collect all your possible benefits is generally not the best policy).

None of us can count on dying on time. And if you’re married, the chances you and your spouse will both die on time are even smaller. Indeed, for 65 year-old married couples, there’s a better than even chance that at least one member will live to his or her early nineties.

We need to plan to live to our maximum age of life, not our expected (average) age of life. For most of us, our maximum age of life is 100 or greater. Why should we plan to live so long? -- for the simple reason that we might.

This is no different from planning for the possibility of our house burning down. Most likely it won’t happen. But if it does, we want to protect ourselves – our living standards – against that outcome. Imagine the government telling you, “Don’t buy homeowners insurance. At best it’s a break-even proposition on an actuarial basis, and you’ll lose money if your house doesn’t burn.”

If we cared just about what we expect to happen (our house not burning), this advice would be reasonable. But we do care about bad things happening, even if we know they won’t happen on average. Here’s the reason: we’re risk averse -- we care more about the downside than we do about the upside.

The downside in the game of life is living too long. If we don’t insure against an extended stay here on earth by acquiring insurance policies that pay more the longer we live, we run the risk of outliving our money.

To repeat: waiting to collect Social Security (with the strong caveats discussed below) lets us buy more longevity insurance in the form of a higher benefit. The price we pay for this extra insurance policy -- the premium -- comes in the form of foregoing benefits in the short term. Uncle Sam is a particularly attractive insurance agent because he charges very inexpensive premiums and sells fully inflation-indexed insurance policies and the company he represents – the federal government – is highly reliable (at least when it comes to paying the Social Security benefits it owes).

If you haven’t yet started collecting, what’s the best option?

If you are cash-constrained (also called borrowing-constrained or liquidity-constrained), ESPlanner can show you the trade off between sacrificing a portion of your current living standard in order to have a higher living standard once you do start to collect benefits. If you aren’t constrained, ESPlanner can show you precisely how much your living standard will immediately and permanently rise by waiting to collect based, again, on ESPlanner’s planning horizon, which extends to your maximum age of life.

Illustrating ESPlanner’s Benefit Calculations

Here’s an example of how postponing Social Security can raise a household living standard, but can also create "liquidity constraint."

Let's assume that both Jack and Jill have been working all their lives, and that Jill has a slightly better earnings history. They are both earning $90,000 a year now. Because ESPlanner asks for the actual earnings history (you can conveniently paste it in from your ssa.gov account) it doesn't need a "rule of thumb" or estimate. It can use the same math that SSA uses to determine your benefit, but it does one better: ESPlanner will also take into account the real wage growth, your cost of living raises, that you might assume to receive up through your last year of work. So, in this case we have assumed that both Jack and Jill will get cost of living adjustments each year through retirement.

Jack is 55 and Jill is 59. Based on entered birth dates, ESPlanner knows that their full age of retirement--the age in which they can receive their full benefit without being reduced for applying early--is age 66. Jack's benefit will be $29,120 and Jill's benefit will be $32,870 when they begin collecting at their respective full age of retirement.

When ESPlanner integrates these amounts with the rest of their economy--taxes, mortgage, retirement accounts, contributions to retirement; for that matter, all future income and expenses that they would like to assume--it reveals that they have a discretionary spending pattern of $88,357 adjusted for inflation each year through age 100.

That's great. It's what we call "a smooth living standard" because there is no liquidity constraint. You can see this illustrated below where the blue line is straight across or smooth.

But what if they postpone Social Security to age 70?

In this case, Jack's benefit rises to $36,497 and Jill's is $42,950. For Jack that is a little over 25% more and for Jill that's a little more than 30% more. That's great! But when we integrate this amount with the rest of their income and expenses, we discover that their discretionary spending is no longer smooth. They are now liquidity constrained. They have $79,738 until they are ages 70 and 74 respectively, after which they have $102,058 of discretionary spending (i.e. spending after off-the-top expenses, in this case mortgage, contributions to retirement, and Medicare Part B).

The following two charts illustrate the difference.

Is this a good trade off? For some it might be for others maybe not. One important point to make is that this does not need to be the final story. With ESPlanner, there are several ways to adjust aspects of the household economy so that the left side of the red line goes up and the right side comes down--but in a way that leaves the red line smooth like the blue line, yet above, representing higher amounts than the blue line. In other words, there are ways to fund the early years on the left with income from the years in the future, and still come out ahead! But that's something we'll cover in a different case study.