I’ve long believed that for those who could afford it and who were in good health, deferring the start of Social Security as long as possible was a no-brainer.
To prove that point, I looked at my own personal situation and considered using distributions from my life insurance policy to bridge the income gap while I delayed Social Security. Ultimately, I was surprised that it was not as clean of an analysis as I expected.
First, I obtained my Social Security projections for retiring at ages 62, 67, and 70. Second, I obtained two different inforce illustrations on my existing life insurance policy:
- Illustration that assumes no distributions are ever made,
- Illustration that assumes that distributions match the after-tax amounts that Social Security would provide without deferral.
I expected a breakeven year around age 80, but to my surprise, I would need to survive until somewhere between 85 and 95 in order to come out ahead with the strategy of using my life insurance cash value to delay Social Security.
How could this be so late, when conventional wisdom is that delaying Social Security is a no-brainer?
It has to do with how attractively the life insurance policy is performing.
My life insurance policy is from a great company and is so well-designed that I would basically be robbing Peter to pay Paul. Pulling money out of my life insurance policy prevents it from earning an extremely attractive risk-adjusted, tax-adjusted return, which marginally hurts the attractiveness of delaying Social Security.
Here’s what I came to realize: If the attractive returns associated with delaying Social Security can only be achieved by sacrificing another attractive asset, then the case for delaying is not as compelling as I originally thought.
Based on the above, I think it unlikely that I will use my life insurance as a funding source to delay Social Security. If my life insurance policies were unattractive investments, then my conclusion would have been different. But that still leaves me wondering when I should start taking Social Security and if delaying is still as attractive as I thought it was.
There are two critical questions that I need to tackle:
- What are my own longevity expectations?
- What is my opportunity cost associated with receiving Social Security payments?
Opportunity Cost
If I’m going to consume the Social Security payments as I receive them (instead of investing them), then my opportunity cost is essentially the inflation adjustment that will occur on the payments going forward.
But if I’m not going to consume those payments and I invest them, my opportunity cost is better represented by the net after-tax return I expect to earn on those investments.
General Rules of Thumb
Here is what I observed in my own analysis:
- The longer I expect to live, the more it makes sense to defer the start of Social Security.
- For instance, if I expect to die at or before age 76, then it almost always makes sense to start taking payments as early as possible (age 62).
- On the other hand, if I expect to die at age 88 or later, then it almost always makes sense to start taking payments as late as possible (age 70).
- For expected ages of death from 77 to 87, the optimal strategy gradually shifted from early to normal to late with advancing age, with the rate of that shift highly dependent on the opportunity cost.
- The lower the opportunity cost, the more it makes sense to defer the start of Social Security. On the other hand, if the opportunity cost is high, then it’s easier to make a case for receiving payments as early as possible, even if they are a reduced amount.
My longevity expectations and personal opportunity cost are something that I will revisit when I approach the election ages. For now, I think I can say that the most likely scenario is that I will defer receiving Social Security as long as possible, but I’m not as confident as I was before I undertook this project.
This type of analysis is one that is going to be different for every individual, and additional considerations such as spousal and tax implications can be relevant. Hopefully walking through this exercise will benefit many others out there!
Does your client need a policy review?
I am an Actuary and a Consumer Advocate (not an insurance agent) who helps high-net-worth individuals with $100,000 or more invested in cash value life insurance or annuities to maximize the value of their policies.
High-net-worth individuals and their advisors hire me to help:
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Analyze existing life insurance policies and annuities to provide customized recommendations for optimizing value
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Consider impact of objectives, longevity, tax considerations, and opportunity cost on life insurance and annuity decisions
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Access/design life insurance policies and annuities that eliminate (or reduce) agent compensation and maximize policy value
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Provide an unbiased perspective free from any conflicts of interest
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Avoid making critical mistakes and provide peace of mind
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Provide a qualified appraisal on life insurance policies
To learn more, please contact me.