If you’re retired and are interested in having a higher income for as long as you live, you have two main options.
You can buy a life annuity. This will provide you with an income, with or without inflation adjustments, for as long as you live. But it will leave nothing for your heirs.
Or you can buy a variable annuity with a variety of living-benefit provisions. These will guarantee a lifetime income. The income will be less than a lifetime annuity, but you’ll have a modest chance of future increases and you may leave something for your heirs.
Whatever you choose, the only thing certain is a lot of fine print.
Fortunately, there is a simple alternative. It will work nicely for retirees in their late 60s or early 70s who opted, years ago, to take Social Security benefits at a relatively young age. That’s millions of people.
If you did this, you know that your benefits are a lot lower than they would be if you had waited and taken benefits later. Your benefits were reduced because taking benefits early meant Social Security would have to pay benefits for more years.
But you can reapply from scratch with these easy steps. Visit the local Social Security office. Make use of a little-known and seldom exercised provision--- request a “Withdrawal of Application.” By filing an SSA Form 521, Social Security will treat you as though you had never applied for benefits. It will let you immediately reapply for benefits--- at your current age.
Yes, there is a catch. And it’s a big one. You must repay every dime you’ve received in past benefits. But because Social Security charges no interest, reapplying turns out to be a really good deal. It represents a way to buy an inflation-adjusted annuity for a price that beats anything offered by the financial services industry.
Here is how it works. If you apply for Social Security benefits before your full retirement age, your benefit is reduced for each month you take it early. If you delay taking benefits beyond your full retirement age, your benefits are increased for each month of delay.
For example, if you were born between 1943 and 1954, your full retirement age is 66. If you retire at age 62, your benefit will be 75 percent of what you would receive if you waited until age 66. In addition, those born in this period will receive an increase in benefits for each month of delay beyond their full retirement age. The increase is two-thirds of 1 percent a month, or 8 percent a year. At age 70 (when increases in benefits stop), your benefit would be 132 percent of your full retirement benefit.
Now let’s put that together. If your benefit at 62 is 75 percent of your full retirement benefit and your benefit at 70 is 132 percent of your full retirement benefit, your monthly check could increase by as much as 76 percent. (The benefit will also be adjusted for inflation over the period.)
If your benefit was $1,000 a month at age 62, you’d have to return $96,000 at age 70 in order to receive a benefit increase of $760 a month. That’s $9,120 more a year. (I’m ignoring inflation adjustments.) In effect, you are buying an inflation-adjusted life annuity with an annual payout starting at a stunning 9.5 percent of your initial “investment”--- the return of money you’d received earlier in benefits.
Now ask yourself a simple question. Where can you find a financial product that will deliver an initial payout of 9.5 percent and adjust it every year, for the rest of your life, at the rate of inflation?
You won’t get a 9.5 percent initial payout with guaranteed inflation rate increase from any of the living-benefits variable annuities. You won’t get it from any of the new mutual funds geared to producing lifetime income. And you won’t get it from a commercially available life annuity with inflation adjustment.
Vanguard, for instance, offers life annuities with inflation adjustments. A request for a quote on a $760-a-month inflation-adjusted lifetime benefit for a single lifetime brought back a cost of $129,085 for a 70-year-old male. That’s a starting rate of 7.1 percent. The same benefit would cost $145,288 for a 70-year-old female, a starting rate of only 6.3 percent. Whether you measure in starting percentages (9.5 percent versus 7.1 percent or 6.3 percent) or in initial investment, the same benefits can be had for a lot less at the local Social Security office.
Professor Laurence J. Kotlikoff at Boston University has examined this issue on his website. He suggests that a somewhat better life annuity rate is available from the Principal Insurance Co. by way of the www.elmannuity.com website. Using his consumption-smoothing software, he also calculates that retirees can reap substantial increases in their lifetime consumption by following this strategy. Readers can learn more by reading the “Reapply for Social Security” case study on the ESPlanner website at www.esplanner.com.
But wait! It gets better.
By reducing investment income and increasing Social Security benefits, many retirees will be able to reduce their income taxes and, quite possibly, avoid the taxation of Social Security benefits.
If some of this sounds a bit familiar to you, it should. I’ve been writing about the Torpedo Tax--- the taxation of Social Security benefits--- for at least five years. I’ve also been suggesting that deferring Social Security benefits was a good “investment” because the math works very much like the math in this column. You get more certain income from deferring Social Security benefits than you can get from virtually any financial product. Deferral is particularly beneficial for married men.
On the web/sidebar:
I know from reader mail that lots of people have a tough time getting their heads around this idea. So here is a list of web-based resources and articles that should be helpful:Social Security Retirement Calculators:
Social Security table of benefit reductions, by month, from 62 to 66
Social Security table of benefit increases, by month, from 66 to 70
Social Security: Request for Withdrawal of Application
Vanguard survival probability calculator:
ESPlanner Case Studies
Earlier columns:November 2, 2007: An Alternative to Living Benefits
February 7, 2006: The Facts of Life (and Death)
January 29, 2006: Fine Tuning the Social Security Benefits Decision
November 22, 2005: Real Life Maximizing of Social Security Benefits
February 11, 2003: How the Tax Torpedo Hits