Timing Social Security: How emotion clouds logic

It seems that people tend to ignore logical arguments for delaying Social Security benefits and let aversion to loss influence them more, a common behavioral finance phenomenon. That's one of the many conclusions from an interesting study recently conducted by the Society of Actuaries (SOA) and Matthew Greenwald and Associates. The two organizations conducted focus groups with current retirees to learn how Americans actually plan for retirement.

Their study showed that many retirees are aware of the so-called "breakeven analyses" that estimate the age you'll need to reach so that delaying Social Security becomes a smart move. Such analyses typically show that you'd need to reach age 78 to make it worthwhile to delay Social Security from age 62 to 66. Similarly, you'd need to live to 82-1/2 to make it worthwhile to delay your benefits from age 62 to 70.

Considering average U.S. life expectancies, most Americans currently in their 60s should live beyond age 78 or even age 82-1/2. And if you have above-average income or education, the odds of longer life are even greater because life expectancy is correlated with education and income.

In spite of this strong evidence, more than one-third of Americans start Social Security at age 62, the earliest possible age -- with the lowest possible benefit. And well more than half claim Social Security before their "full retirement age," which is currently 66.

The study offers insights into the emotions involved in deciding when to start claiming Social Security. People may understand that they win if they live to the breakeven age, but they also think they lose if they die before that point.

And here's where loss aversion comes into play: Most people fear losing more than they enjoy winning. As a consequence, they make decisions that protect themselves against losses, even if this action reduces the chances of a gain.

When you think about it, this doesn't really make sense if you apply this interpretation of loss aversion to claiming Social Security. Let's look at an example to understand why. Suppose you're age 62, you listen to the arguments for delaying Social Security, and you decide to delay benefits until age 66. Now suppose you die at age 65. Oh, no -- you lost!

But wait -- do you really think you'll be up in heaven thinking, "Dang! I should have taken Social Security at age 62!" My actuarial training doesn't qualify me as an expert on the afterlife, but I doubt you'll be regretting your Social Security decision if you're dead.

Let's consider another scenario. Suppose you're 62 and you decide to start Social Security (getting the lowest possible income), and then you're still alive at 85 (much more likely than dying at 65). You've lived well past the breakeven age of 78.

Suppose also that your health care costs increase significantly in your late 70s, and by your early 80s, your income doesn't cover your living expenses anymore. Think about it: You're alive but broke. That's the loss I fear and want to prevent.

There's even more to consider if you're married. Let's go back to the first scenario. For a married couple in this situation, most of the time, the surviving spouse would have a larger Social Security income due to the decision to delay taking benefits. So, if you're really worried about what you'll be thinking in heaven, realize that you'll be pretty happy knowing you made the best decision for your surviving spouse.

Still not sure what to do? This is where "framing" -- another behavioral finance phenomenon -- can help out.

If you frame the potential loss you want to avoid as wishing from heaven that you'd started Social Security early, then you should take it as soon as possible. On the other hand, if you frame the potential loss to avoid as being alive and broke at an age when you're most vulnerable, or leaving your surviving spouse in poverty, then you should delay taking Social Security until at least age 66, but preferably until 70, if you can wait that long.

While it might seem like an oxymoron, you'll make better decisions if you think logically about the emotions involved when planning your retirement.

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    Steve Vernon helped large employers design and manage their retirement programs for more than 35 years as a consulting actuary. Now he's a research scholar for the Stanford Center on Longevity, where he helps collect, direct and disseminate research that will improve the financial security of seniors. He's also president of Rest-of-Life Communications, delivers retirement planning workshops and authored Money for Life: Turn Your IRA and 401(k) Into a Lifetime Retirement Paycheck and Recession-Proof Your Retirement Years.