A hidden Social Security benefit

Now ask yourself a simple question: Where can you find a financial product that will deliver an initial payout of 9.5% and adjust it every year, for the rest of your life, at the rate of inflation?

Answer: Nowhere.

You won't get a 9.5% initial payout with guaranteed inflation-rate increase from any of the living-benefits variable annuities. You won't get it from any of the new mutual funds geared to producing lifetime income. And you won't get it from a commercially available life annuity with inflation adjustment.

Vanguard, for instance, offers life annuities with inflation adjustments. A request for a quote on a $760-a-month inflation-adjusted lifetime benefit for a single lifetime brought back a cost of $129,085 for a 70-year-old man. That's a starting rate of 7.1%. The same benefit would cost $145,288 for a 70-year-old woman, a starting rate of only 6.3%. Whether you measure in starting percentages (9.5% versus 7.1% or 6.3%) or in initial investment, the same benefits can be had for a lot less at the local Social Security office.

Professor Laurence J. Kotlikoff of Boston University has examined this issue on his ESPlanner Web site. He suggests that a somewhat better life annuity rate is available from Principal Insurance by way of the ELM Income Group Web site. Using his consumption-smoothing software, he also calculates that retirees can reap substantial increases in their lifetime consumption by following this strategy. Readers can learn more by reading the "Reapply for Social Security" case study on ESPlanner.

More advantages

But wait! It gets better.

By reducing investment income and increasing Social Security benefits, many retirees will be able to reduce their income taxes and, quite possibly, avoid the taxation of Social Security benefits.

If some of this sounds a bit familiar to you, it should. I've been writing about the "Torpedo Tax" -- the taxation of Social Security benefits -- for at least five years. I've also been suggesting that deferring Social Security benefits was a good "investment" because the math works very much like the math in this column. You get more certain income from deferring Social Security benefits than you can get from virtually any financial product. Deferral is particularly beneficial for married men.

On the Web

I know from reader mail that lots of people have a tough time getting their heads around this idea. So here is a list of Web-based resources and articles that should be helpful:

• Social Security retirement calculators.

• Social Security table of benefit reductions, by month, from 62 to 66.

• Social Security table of benefit increases, by month, from 66 to 70.

• Social Security request for withdrawal of application (.pdf file).

• Vanguard survival probability calculator.

• ESPlanner case studies.

Questions about personal finance and investments may be e-mailed to scott@scottburns.com. Questions of general interest may be answered in future columns. More columns by Scott Burns can be found here and here.

Published Feb. 20, 2008

< previous |  1 | 2 |