Page 30 - Investment Advisor March 2021

Cover Story

Sophisticated analyses take into account the tradeoff of client by tens of thousands of dollars if they fail to consider the
receiving no income during the deferral period and more value of larger income payments made later in life.
income later in retirement. The losses are particularly acute Insurance companies price the cost of creating an annuity
for women and healthier Americans (often those with higher based on the present value of mortality weighted future pay-
incomes) who receive the same annual income increase from ments. If the probability that a healthy woman will be alive
deferral but can expect to receive this income over more years at age 90 is 50% (according to the Society of Actuaries table
than the average American, as they tend to live longer. for annuity buyers), then the value of a $30,000 payment will
Claiming early can be tempting for retirees who are worried be $15,000.
about the solvency of Social Security. As Boston University Discounting the current rate on inflation-protected U.S.
economics professor Larry Kotlikoff has pointed out, if Social government Treasury bonds (TIPS), which recently was -0.5%,
Security income is eventually cut (which is unlikely) the the present value of this payment is exactly $17,000. In a mar-
income of those who claim early will be cut by the same per- ket that prices inflation-adjusted payments with a negative
centage as those who claimed later. discount rate, the value of Social Security is higher than when
If benefits get a 23% cut in 2034, the average present value TIPS rates are positive.
(or PV) of payments for a male claiming at 62 is $678,124, and An advisor evaluating deferral strategies should think
$764,084 if he claims at 70. Cutting benefits earlier than 2034 like an insurance company when estimating the value of
will only increase this difference. Without a benefit cut, the claiming at different ages. How healthy is my client com-
difference between claiming at 62 and 70 is $131,951 ($818,747 pared to the average American? If they’re healthy, this
vs. $950,698). increases the present value of any claiming strategy that
increases future income.
Advisors and Present Value How healthy (and what age) is their spouse and how much
As Kotlikoff’s present value calculations demonstrate, getting will the deferral affect the spouse’s income? What is the cur-
the claiming decision right can add the equivalent of a six-fig- rent market rate of return on inflation-protected securities?
ure windfall to a retiree’s balance sheet. Advisors who cling to Higher Social Security income is worth more when the mar-
less accurate methods, such as the breakeven age, to evaluate ket places a greater value on inflation protection and nominal
the benefits of various claiming options may shortchange their interest rates are low.

Social Security COLA: What’s Working, What’s Not

The inflation protection provided through Social Security is an Should advisors be worried that this impor-
often overlooked but important benefit that makes it a valuable tant benefit will disappear?
tool for funding basic retirement expenses. Social Security recipi-
How are Social Security benefits adjusted for inflation, and ents will receive a 1.3%
can we expect these annual income increases to continue cost-of-living adjust-
in the future? Does the inflation adjustment do a good job ment (COLA) to their
of increasing income when retirement monthly benefits beginning
expenses rise? in January 2021. The aver-
The expected shortfall in the age Social Security retire-
Social Security trust fund ment benefit in 2020 is
means that policymakers will around $1,500.
soon be looking for ways Therefore, the “average”
to shore up the system’s retiree will receive an approx-
finances. imately $19.50 increase in
Reducing inflation their monthly benefit check, or
adjustments offers the $234 for the year. This increase
dual political benefit of is on top of the 1.6% increase
avoiding a reduction in for 2020.
the size of Social Security Social Security benefits only rise
checks and reducing the size when prices go up; in years with low
of future payroll tax increases. price inflation, they remain steady.

28 INVESTMENT ADVISOR MARCH 2021 | ThinkAdvisor.com