Social Security as a Cheap Annuity Option (Part 1 of 2)

A recent report released by the Center for Retirement Research at Boston College shows that Social Security is one of, if not the cheapest annuities available (click here to see the report). “Well that doesn’t make much sense” you might be saying to yourself. After all, you don’t “buy” your Social Security annuity payments right? You’re simply entitled to receive them after meeting certain requirements.

In this case, both sides have an argument. It’s true that once you’ve met certain minimum requirements (click here for more info on Social Security eligibility) you’re entitled to Social Security annuity payments without any further cost on your part. However, there isn’t just a single age when everyone begins to receive Social Security. Instead, there’s a range of ages during which you may begin receiving payments.

Depending on your year of birth, you may have any number of “full retirement” ages, but it’s generally somewhere between 66 and 67. Full retirement age is the age at which you are entitled to receive your “full” retirement benefit. You can choose to begin receiving Social Security retirement benefits before this time, as early as age 62, but if you choose to do so, your full retirement payments may be cut by nearly 25%. In contrast, you can also choose to delay taking payments until you turn 70. By opting to do so, you’re annual social security payments will increase. For those born in 1943 or later, that increase is 8% per year, and that doesn’t include any cost of living adjustments that may also kick in.

Knowing that, we can now see what the “cost” of “buying” an annuity from Social Security would be. This is getting a little cumbersome, so let’s use an example to make things a little clearer. Suppose that your full retirement age is 66 years old and that you are entitled to annual Social Security payments of $10,000 at that time. Now let’s assume that instead of taking Social Security payments at that time, you deferred for one year.

Remember, anyone born after 1943 would get an 8% raise (not counting any additional inflation adjustment) for doing so. As a result, at age 67 (one year after your full retirement age), you are now entitled to annual Social Security payments of $10,800 ($10,000 x 1.08 = $10,800). For simplicity sake, let’s say that at that time, you chose to begin receiving your Social Security payments.

Using our example, the “cost” of waiting that one year to receive the higher benefit is $10,000. After all, if you’d have taken the payments at 66, you would have had an additional $10,000 in your pocket, right? Now comes the second part of the equation; What annuity did that $10,000 payment buy you? A $10,800 per year annuity? Nope, remember that if you had taken Social Security right away you already would have received $10,000 of that amount, so the annuity you’ve “bought” is the difference between the two, or $800 ($10,800 – $10,000 = $800).

According to the study, if you compare the cost of buying this annuity to other alternatives, you’re usually going to find it’s a less expensive option. Plus, unlike many other lifetime income options, Social Security payments are indexed for inflation, meaning that the additional $800 you receive will increase in future years along with the costs of goods and services, helping you to retain your purchasing power.

That’s nice, but what does this mean for IRA owners? Find out next Wednesday right here at The Slott Report.