Extending the Case Study on When to Collect Social Security: Economic Decision Making for Couples

The decision of when to start collecting social security benefits is a complex one. Many people must answer the question of whether to start collecting reduced benefits at age 62 or wait until age 66 (or later) for regular payments. Most available literature, including the publications of the Social Security Administration, focuses on the dollar difference in monthly payments and completely disregards the time value of money. For single individuals, this is a complicated decision. For couples, the decision making process is much more complex. Couples facing the question of when to start collecting benefits have more options than do single people. For example, anyone may elect to start collecting early at age 62. However, if one’s spouse is already age 66, they may elect (starting at age 62) to collect up to half of their spouse’s benefit. Or they may start collecting their own benefit, and switch to collecting spousal benefits if that is in their best interest. Also, a widow(er) may collect survivor’s benefits. The best strategy for defining both people’s benefit plans depends on each other’s, and opens many options. Of course, other considerations such as health and income sources become a part of the decision. Much of the literature ignores the need for couples’ strategies. A better way to approach the question is to use decision analysis tools that incorporate the time value of money. These tools are taught in engineering economy courses and the social security for couples issue can be used as a case study to apply these tools to real issues faced by students’ parents, grandparents, and instructors. The focus here is pedagogical. What information is needed, and how can it be put together to identify optimum choices? The difference in couples ages, the difference in past income, and current and future work status all combine to create many different possible scenarios and many different best choices. Introduction The Social Security system provides retirement benefits to most of the people that have an extended work history in the U.S. For those people born between 1943 and 1954 (those who are retiring now and in the near future), the full retirement age is 66. Most people are eligible to begin benefits as early as age 62, and as late as age 70. However, retirement is not a requirement to begin taking benefits. Choosing whether or not to retire is heavily influenced by lifestyle choices that may or may not be constrained by economics. Benefits from social security may be paying for necessities such as food, rent, and medical care or for discretionary expenses such as travel or college for grandkids. It is not possible to model whether work is fulfilling or exhausting, or whether family needs dictate that a person should retire to take care of an ailing or aging spouse or parent. A person may want time to travel the world or to live near grandchildren, time to focus on a favorite hobby, time to make a difference by volunteering, etc. Receiving social security benefits may make choices possible, but valuing those choices is impossible to generalize for a wide population. In addition, some people choose to continue to work past the normal social security retirement age, and draw benefits while still working full time. Thus, a case study that addresses P ge 23584.2 the “retirement” decision must be for an individual or family, and its non-economic features will dominate the economic analysis of the time value of money. The choice of when to begin collecting benefits is an important personal decision. Quite often, the recommendation is “wait until you are 70 because the monthly benefit is higher.” This is regularly provided by Social Security offices. For some people, this is a good answer, but for many, this answer is not the best. Many people approaching the decision of when to start collecting benefits are married or widowed, and there are more options for couples than for single people. The regulations regarding Social Security are complicated, especially regarding couples, and the decisions are not simple. Because people can begin collecting benefits at age 62, the decisions need to start at that time. Economic decision tools are useful in helping to make the best decisions of when to begin receiving benefits. This paper discusses possible cases regarding the analysis of social security benefits for couples. This involves time value of money, comparison of alternatives, and economic decision making. Any of the example cases may be kept fairly simple by specifying all variables, or a case may be expanded by incorporating a range of possibilities and performing sensitivity analysis. Rules can be provided to the students, or left for the students to research them. Cases can have a nearly infinite variety by changing the ingoing assumptions. Case studies of this type more nearly approximate real world issues and help to demonstrate the use of economic tools beyond what can be done with end of chapter problems. The cases included here provide an outline of how to approach a fairly complicated issue by analyzing one step at a time. While we use social security as an example, similar problems can be created using any defined benefit program. A short series of cases is given, demonstrating how couples strategies differ from that of singles strategies, and how various engineering economy tools may be used to support the needed decisions. Our 2012 paper was class tested during the spring 2012 semester. In that situation, students worked in teams and were given an open ended problem, where a person’s income was given, but whose age of death was unknown and uncertain. Student teams typically started work two weeks before the due date, working on the case outside of class. Results, including sensitivity analysis, were then presented by the students in class and discussed. Feedback was very positive because they saw a direct application of newly learned tools to a realistic situation. One student reported that a discussion of the social security case occupied twenty minutes of a job interview, where the employer was looking for evidence that the student was able to use spreadsheets as applied to a real-world economic problem. She received and accepted the job offer. Literature Review The Social Security Administration website is a likely first stop for students looking for information. The website is written in understandable English, but is often short on hard information unless the right location is found. The website does not make recommendations. A compilation of the Social Security regulations is also available, but these are written in typical government legalese, are virtually unreadable, and are not recommended as a source. There is a variety of material available, much of it providing conflicting recommendations. There are recommendations to not take benefits at age 62, 5 as well as those recommending to wait until 70, 7 while others write about the risk of postponing until 70. While the Social Security Administration website focuses on monthly benefits, others use various discounted P ge 23584.3 cash flow tools. 10, 11, 12 Others say the timing of beginning benefits depends on the real interest rate. 14 Information regarding strategies for couples is more limited. 16, 17 The best reference we have found for detailing the many facets of couples strategies is from Reichenstein and Meyer, which has proven to be an excellent resource. Determining Benefit Amounts Identifying the average indexed monthly earnings (AIME) is the first step for determining benefits. An individual’s earnings record is indexed for inflation, using the national average wage index, published by the Social Security Administration. A person’s highest 35 years of earnings are used in the calculation. The index is updated annually based on average wages, not the cost of living. The most recent update was October 2012, which added 2011 wage information. A person’s monthly benefit is based on their primary insurance amount (PIA). The PIA is the monthly benefit that a person would receive if they start benefits at their full retirement age (FRA). The computation of the PIA uses a formula which contains two “bend points” that increase with inflation. For 2012, the bend points were $767 and $4624. For 2013, the bend points are $791 and $4768. For 2013, the PIA calculation is as follows: If AIME < $791, PIA = (0.90)(AIME) If $791 < AIME < $4768, PIA = (0.90)(791) + (0.32)(AIME – 791) (1) If AIME > $4768, PIA = (0.90)(791) + (0.32)(4768 – 791) + (0.15)(AIME – 4768) So a person having an AIME is $5000 has a PIA of $1980.90 in 2012 and $2019.30 in 2013, an increase of 1.9%. The schedule is progressive and the social security benefit may nearly replace pre-retirement income at low incomes—half-time at minimum wage. When analyzing these problems, we need to have a common measure of economic value. The most common measures in the popular literature are the monthly benefit and the total amount of benefits received over a period of time (without considering the time value of money). Although real interest rates continue to be low at the present time, we do not believe that this will continue for the next several decades while we are still alive and hopefully collecting benefits. Discounted cash flow techniques are highly recommended, and this paper will use present value. Summary of Relevant Social Security Rules Rules can be given to the students as part of the case study, or students can be directed to research them. The Social Security website has much of the information, but it can be very time consuming to find all of the relevant information. The important rules are captured here to assist the reader in walking through the proposed cases. We will limit our discussion to people who were born between 1943 and 1954, as this group shares the same full retirement age of 66 years. This age slowly increases for people born after 1954. P ge 23584.4 A person w