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It’s a fiscal Sword of Damocles hanging over America’s future: If no changes are made to the way we operate and finance the Social Security system, its trust fund will run dry around 2033, after which the program will have to pay for itself through ongoing payroll taxes. Those will only be sufficient to cover benefits at about 66% of current levels, according to Olivia Mitchell, professor of business economics and public policy at Wharton.
The most common solutions that have been suggested to avoid that unpleasant eventuality are raising the retirement age, cutting benefits, increasing payroll taxes or lifting the payroll tax cap on incomes above $118,500 — earnings upon which the wealthy currently pay no Social Security taxes at all. Politically, all of these options are deeply unpopular to one faction or another.
But Mitchell, a recognized expert on retirement and Social Security, has done research that supports a novel way to boost the trust fund’s life span, in a way that is revenue neutral. Her study is being published as an issue brief by the Penn Wharton Public Policy Initiative. The brief was co-written with Raimond Maurer, a professor at Goethe University, Ralph Rogalla, a professor at St. John’s University and Tatjana Schimetschek, a research assistant at Goethe University. Mitchell recently spoke with Knowledge@Wharton about her findings.
An edited transcript of the conversation appears below.
A New Way to Delay
Around the world, social security systems are running out of money. We’re not unique in the United States in that regard. And the typical policy recommendations are not very popular, like raising the retirement age or cutting benefits or raising taxes. What we set out to do in our research is to try to think of a new way to get people to delay claiming benefits, work longer and have all that happen without Social Security suffering financially.
In a nutshell, what we set out to do was to design a way to give people the benefit increases that they would receive if they delayed claiming, but instead of giving them their benefit increases as part of a monthly payment, we would give it to them as a lump sum at their later claiming date. The money turns out to be quite substantial, from $60,000 to $80,000 to $170,000. This is the actuarially neutral value of the additional benefit. And lo and behold, people like this idea.
In our experimental survey, what we found is that people would delay claiming benefits for about half a year, and they would work about a third to a half of the extra time. All of that takes place without costing the Social Security a penny on net.
“Today, more than a third of Americans claim their benefits from Social Security as early as they can, which is age 62.”
The Benefits of Waiting
What we find is that today, more than a third of Americans claim their benefits from Social Security as early as they can, which is age 62. And the modal claiming age is about 63. So most people give up on the increased benefits that they could get if they waited till the latest possible claiming age. In our current system, the latest possible claiming age is age 70. It’s a little known fact that if you wait to claim from age 62 to 70, either by continuing to work or living on other assets, your benefits go up by 76%. This is an enormous increase — and probably a better investment than what most people can make in the market today.
The Lure of a Lump Sum
The problem, however, is that people don’t understand annuities. They don’t understand benefit increases that will be paid the rest of their lives. So what we’re trying to do is take advantage of the fact that people don’t understand how their benefit increases for the rest of their life. Instead, what we do is we say: All right, if you’re someone who would receive $1,500 a month from Social Security if you claimed at age 62, under our scenario, you still get that $1,500 a month if you claim, let’s say, at age 66. But all the benefit increases you earned by delaying claiming would be given to you as a lump sum at that later claiming date. And what we find is people like lump sums, not surprisingly. A bird in the hand seems worth more than two in the bush.
A Neutral Solution
The Social Security Administration computes the benefit increase that you get each year that you delay, so that the increment is just enough to offset the fact that you’re not taking it for a year. So in a sense, it’s actuarially neutral. It’s actuarially fair. It doesn’t hurt the Social Security system, it doesn’t save it any money. In that sense, what we proposed in our experiment was to give people the benefit that they would get already in expectation, but convert it into a lump sum.
Now not surprisingly, the people who are willing to do it are the people who are somewhat debt constrained. They have debts that they owe. They would still get the basic benefit that they’re owed, but the lump sum would help them solve their debt problems. Other people who find it very attractive are the financially literate — people who understand that they’re going to get money that would help them cover other expenses, and still get their base benefit for the rest of their lives.
The Limitations of Financial Advisors
“What we find is people like lump sums, not surprisingly. A bird in the hand seems worth more than two in the bush.”
Unfortunately, my research shows that a majority of financial advisors use a very flawed approach to advising on Social Security claiming, which they call the “break-even approach.” It’s extremely misleading, because they say to you, “You will have to live to some age” — say, 84 — “to get all the money back that you gave up by not claiming early.” That’s a very flawed approach. And the reason that it is, is that it ignores the fact that by delaying claiming, the retiree gets a higher benefit for the rest of his life, even if he or she lives to be 125 years old. So I would take issue with the break-even approach. I don’t think it’s an appropriate way to frame the discussion.
What we did was, we fielded a survey — a nationally representative survey of older Americans — and we asked them before we got started some questions about their lifetime earnings so we could get a pretty good estimate of what their expected Social Security benefits would be at future ages. Then we said, under the current system, when do you expect to claim. And they’d tell us. Then, we’d show them the alternatives — the lump-sum option, for example — and we’d say, given this set of opportunities, when would you claim? Not surprisingly, the majority of people selected a later claiming age. We could then examine that delay in the claiming age, and correlate it with attributes of the person answering the question.
One of the things that really surprised me was that we found that people who otherwise would have claimed very young, at 62, were the most likely to be willing to delay claiming. The reason that surprised me is that there’s a common view that early retirees can’t work anymore. They’re too sick. They’re too unable to find jobs. But in fact, this suggested there’s a lot of give among the early retirees. If you give them an incentive to delay claiming, they will delay, and they’ll work longer.
The Future of the Trust Fund
Well, the Social Security Trustees have projected that there will be only enough money to pay two-thirds of the current level of benefits starting around 2032, which is getting closer as the years go by. So benefits would be projected to drop by a third for everyone. The way we’ve designed our experiment, we made it actuarially neutral so that it wouldn’t hurt the system’s finances and it wouldn’t help the system’s finances. But we do say at the end of the paper that to the extent that people really prefer lump sums, that it might be possible to get them to delay claiming and work longer for a little bit less than the actuarially fair amount, which would actually save the system money.
“There’s a lot of give among the early retirees. If you give them an incentive to delay claiming, they will delay, and they’ll work longer.”
Making up the Gap
The follow-up study that we intend to do will vary the amounts that we offer people, not necessarily making it a better deal because the system can’t afford that, but trying to evaluate whether people might take the lump-sum benefit if it were slightly reduced. My sense is it will, in fact, be popular.
The Social Security shortfall is enormous. The actuaries have estimated that it’s on the order of $28 trillion in present value. That’s twice the size of the GDP of the U.S. So a small delay in claiming will not solve the problem. I think we’re also going to have to have changes in the benefit formula. We’re going to have to have changes in the retirement ages. But given that there need to be a number of different tweaks or adjustments, this could easily be one that makes it more palatable to people. We’re not taking away anything from people — we’re giving them options. I hope that’s more appealing than saying, “You must work another five years.”
We are looking further at alternative ways to get people to delay claiming benefits and work longer. There is some interesting research that’s being done now showing that delayed retirement is actually better for you. It’s better for you mentally. You stay networked with your peers. It’s better for you physically. People who work longer are healthier. And it’s also better for a society, in that if you encourage continued work, you don’t have to raise taxes so much on the young to be able to support the elderly. So for a number of different reasons, I’m very much in favor of delayed retirement. Not everyone will be able to do it, but to the extent you can, let’s encourage it.