May 29, 2012 — Of course you really can’t buy an annuity from the Social Security Administration – but in a manner of speaking you can do something that has the same effect. Last week we came across this seemingly whacky article from the Center for Retirement Research at Boston College, Should You Buy an Annuity from Social Security”. After reading it we think it turns out to be one of the cleverest ideas we’ve heard for a long time.
The biggest financial challenge for today’s retirees is coming up with enough income to pay for a comfortable retirement. Consider these trends:
– The Bureau of Labor Statistics reported that in 2008 only 20% of workers had a defined benefit (traditional) pension plan, and that percentage is headed downward.
– Only a handful of people have saved enough for retirement. Indeed the Employee Benefit Research Institute found in a recent survey that 56% of all workers have saved less than $25,000 for retirement.
– At a generous 4% return, that $25,000 would only produce $1000 a year in income
– The average social security benefit for a couple in 2012 is $23,928, not a whole lot more than the 2012 poverty level in the 48 contiguous states for a 2 person household, $15,130.
In our previous series on Social Security we stressed how waiting until full retirement age or until age 70 provides a very large benefit vs. claiming before that – if you can afford to delay. This is one part of the “buying an annuity” thesis. Another key part of this idea is that your social security benefit is an inflation protected asset, thanks to annual COLA’s. Your other investments are not generally inflation protected, so once you deduct inflation from any returns you are probably not doing as well as you are from social security. These two facts are at the heart of the CRR’s idea of a social security annuity.
The essence of the “buy an annuity from Social Security” idea
An annuity is a contract where you give up a fixed amount of your savings in exchange for an annual payment for the rest of your life. You generally buy them from insurance companies. The gist of the “buy an annuity from social security” idea is that you delay taking social security, “spending” your savings to replace that social security income. For that “purchase” you receive a higher benefit from social security for waiting (the annuity). By using your savings you will not only be earning a very healthy rate of return from increased SS benefits, but you will be gaining benefits that are inflation-indexed. In effect you are “buying” an annuity from Social Security, and the payment you receive is the inflation protected, extra benefit from delaying your claim.
The CRR site has more details that will explain exactly how this works. We recommend you read the full brief to fully understand the concept, but here are a few bullet points:
– The increase in inflation protected monthly income for delaying social security from age 62 to 70 is 76%. This amazing fact makes crystal clear why delaying is a good idea.
– The annual rate of return from a typical, commercially available inflation protected annuity for a husband (65) and wife (63) is 3.7%.
– If you were to use your savings as your income (and delay taking social security) between the ages of 62 and 70 your annual rate of return would be 5.4%, a full 1.7% higher than you could get from a typical commercially available annuity.
Impact of taxes uncertain, but probably minimal
The CRR brief did not address the impact of taxes on this strategy. Assuming that your only income would be from your savings or from social security, taxation is probably not a factor at those low income levels. If instead of using your regular savings you took a distribution from your IRA or 401k to buy the annuity, you would have to pay taxes on that income. However once again, if that were your only income, the taxes on it would probably be minimal. But as with all financial decisions, consult with a tax professional or financial advisor before acting.
For further reference:
Social Security Part 1: What You Think You Know Might Hurt You
Social Security Part 2: Claiming Strategies for Couples
Should You Buy an Annuity from Social Security”.
Note: Be sure to take our new “What is Your Social Security IQ Quiz“. It will give you a score and detailed explanations to make you a Social Security expert (our best advice, read this article first!).
Comments Anyone? We love to know what you think about this strategy. Please let us know in the Comments section below.