Making Optimal Social Security Claiming Decisions
CONSULTANT TO AVANTIS INVESTORS®
What career to choose, who to marry, which house to buy. There are high-stakes decisions we typically make infrequently in life. But deciding when to claim Social Security is a choice we usually make just once. And for retirees whose incomes may be heavily dependent on Social Security Administration (SSA) benefits, it’s a decision with significant economic impact that can be felt over decades.
Choosing early (at age 62) implies smaller benefits sooner, while choosing late (at age 70) delays the start of benefits but could result in almost double the monthly income. Research on how individuals think about the tradeoffs in when to start SSA benefits and the behavioral biases that affect the valuation of those tradeoffs suggests many people are not choosing optimally.
In this article, I’ll review the psychology of Social Security claiming and suggest how financial advisors can guide their clients toward making claiming decisions that may lead to better retirement outcomes.
Setting aside individual differences in budget constraints and family situations, both of which are extremely important to this decision, let’s begin by simply considering the overall financial impact of different claiming ages. Two traditional ways of evaluating the financial tradeoffs of claiming SSA benefits at different ages are to compare the net present value (NPV) of the stream of payments or to calculate a “breakeven” age at which the cumulative value an earlier stream of smaller payments crosses the cumulative value of a later stream of higher payments.
Using NPVs to compare outcomes will, of course, depend on assumptions about discount rates and mortality. Small differences in assumptions can lead to very different recommendations, and research suggests many people end up undervaluing the lifetime benefits.1
The second approach provides individuals with a simple question—"Do I expect to survive past this breakeven age?”—and research has shown that it regularly leads to earlier claiming relative to other approaches.2
In both approaches, typical decision-making biases, such as impatience (i.e., high discounting of future outcomes) and sensitivity to framing, are likely to influence decisions. Neither approach considers other aspects of the decision, such as emotions, nor reliably leads to claiming decisions that are optimal for that individual.
Optimal Claiming Decisions
What evidence do we have that current decisions about Social Security claiming may be less than optimal? As noted above, it is extremely important to recognize that each retiree’s situation is unique, and there is no single recommendation that everyone should claim earlier or later. Some retirees may not have other sources of income to rely on, such as retirement savings or pensions, which allow them to delay their income from claiming.
In contrast, some retirees may both have other income and expect a longer-than-average life expectancy, thus making delay a financially optimal decision.3 Although everyone is unique, it is well documented that most retirees do not wait until their full retirement age to claim, as we might expect if retirees were normally distributed in their financial situations.
In fact, around 30% of retirees claim as soon as they are eligible at age 62, while less than 10% wait until age 70 when their monthly benefits are maximized.4, 5 In other words, the overall data suggests a bias toward claiming early, which can harm retirees’ long-term financial well-being due to permanent lower benefit levels.6
Some retirees should almost certainly claim at age 62, but we should expect to see a larger proportion of the population claiming later than we currently do. What drives this tendency to claim early? To better understand the claiming decision, it is helpful to think about how individual psychology may influence retirees’ thinking about benefits.
Psychological Inputs to the Claiming Decision
While much prior research has focused on how behavioral biases may affect financial valuations of SSA retirement benefits, my coauthor John Payne and I set out to better understand how psychological individual differences may affect decisions independent of changes in valuation.
We focused on two psychological influences: individual feelings about ownership of future benefits and individual levels of loss aversion. In our work, we also collect information about our respondents’ life expectations, patience for delayed rewards, demographics (like income and education), and beliefs about the solvency of the Social Security system.
Each of these other measures plays a role in the claiming decision in predictable ways. However, even controlling for these differences, the psychological measures matter significantly, and their effects are often larger than the traditional measures.7
Let’s start with the idea of psychological ownership for future retirement benefits. Psychological ownership is the feeling that something is “mine;” it is important to note that this feeling can exist even when the individual does not actually have legal ownership.8, 9 We propose that, just as strong feelings of psychological ownership toward an object can increase that object’s perceived value, strong feelings of psychological ownership toward future retirement benefits can increase a retiree’s desire to begin accessing those benefits as soon as possible.
In our research, we measure psychological ownership through agreement with statements like, “The Social Security benefits that I will receive come from the money that I contributed,”* and “I deserve the payments I contributed over my working life.” Indeed, we find psychological ownership toward benefits is one of the strongest factors predicting early claiming.
For example, using an equivalence to life expectations, a 1 standard deviation increase in psychological ownership is equivalent to 7.75 fewer years in life expectation in its effects on claiming intentions, a difference that leads to significantly earlier claiming.
The next psychological input we consider is an individual’s sensitivity to perceived losses, aka loss aversion. Loss aversion and risk aversion are often seen as making similar predictions, such as for financial gambles. A risk-averse gambler may dislike the uncertainty of the outcome while a loss-averse gambler may dislike the possibility of losing money, and so both will turn down the gamble. However, the effects of loss aversion and risk aversion can lead to vastly different predictions within insurance-type decisions such as choosing the level of Social Security claiming income.
When it comes to benefit claiming, greater individual levels of risk aversion should lead to a desire to delay claiming since delayed claiming reduces the possibility of low levels of wealth in case of a longer- than-average lifespan (i.e., later claiming helps protect against longevity risk). In contrast, high levels of individual loss aversion can lead to earlier claiming since the person may be worried about “not getting their money’s worth” from the system if they die early.
In our research, we find that a person with a loss aversion coefficient 1 standard deviation higher than the average will be likely to claim almost four months earlier than someone with 1 standard deviation below the average.
These psychological influences on the Social Security claiming decision, when combined with the emotional aspects of retiring and underlying uncertainty about life expectancy, health and family expectations, make it a decision that many people find difficult to make optimally. Good guidance during the working years leading up to retirement and at the point of retirement itself are essential for improving the long-run outcomes that depend on this significant source of retirement income.
How Advisors Can Help Guide the Claiming Decision
Social Security can be one of several income sources during retirement. While the optimal claiming answer will need to factor in the proportion it represents, informed decision-making in this domain can create more flexibility in how retirees manage the rest of their retirement income and wealth.
Advisors who treat the claiming decision as one element of the larger portfolio can be more effective at guiding a successful decumulation glidepath. The following aspects of the claiming decision are important to keep in mind:
Start with understanding the individual’s perceptions of their life expectations. In our work, we have found it important to always talk about these expectations in terms of the likelihood of living to older ages rather than the chance of dying younger.10 Asking about the chance of living to an old age helps retirees imagine all the reasons they may need to make their retirement incomes last a long time.
Since feelings of ownership can cause individuals to want to claim earlier, a frank conversation about these feelings may help clients think more carefully about what would be most optimal for their situation. Reminding them that Social Security operates differently from a defined contribution plan and rewards from waiting to claim can be financially substantial, may help counteract the emotional desire to claim “my” benefits.
Loss aversion concerns about “losing out” if benefits are not claimed early can also be a strong emotional driver of the decision. Presenting the benefit claiming decision in terms of the breakeven between claiming early versus claiming later may exacerbate this effect. Redirecting clients’ attention to the cumulative benefit over time of higher monthly amounts from later claiming may help counteract this concern over potentially losing out.
In recent work, we have found that asking individuals to think about their recommendations for others about the optimal claiming age can lead to more optimal decision-making for themselves.11 This likely results because suggesting choices to others typically involves fewer emotions than making a choice for oneself. So, to help individuals stay more unbiased in their claiming decisions, have them start by thinking about recommendations for similarly situated retirees.
Amid all these efforts, it is important to continue to recognize that everyone’s retirement journey is different. The optimal solution for one individual may not be optimal for others. Financial advisors can play an important role in helping plan the roadmap for this once in a lifetime trip.
*Agreement with this question suggests individuals may see the Social Security system as something resembling a defined contributions plan, rather than its actual design of a pay-as-you-go system.
1 Jeffrey R. Brown, Arie Kapteyn, Erzo F.P. Luttmer, and Olivia S. Mitchell, "Cognitive constraints on valuing annuities," Journal of the European Economic Association 15, no. 2 (2017): 429-462.
2 Jeffrey R. Brown, Arie Kapteyn, and Olivia S. Mitchell, "Framing and Claiming: How Information‐Framing Affects Expected Social Security Claiming Behavior," Journal of Risk and Insurance 83, no. 1 (2016): 139-162.
3 John B. Shoven and Sita Nataraj Slavov, "Does it pay to delay social security?" Journal of Pension Economics & Finance 13, no. 2 (2014): 121-144.
4 Annual Statistical Supplement, 2020, Social Security Administration.
5 John B. Shoven, Sita Nataraj Slavov, and David A. Wise. “Social Security claiming decisions: survey evidence,” NBER Working Paper 23729, National Bureau of Economic Research, (2017).
6 Gopi Shah Goda, Shanthi Ramnath, John B. Shoven, and Sita Nataraj Slavov, "The financial feasibility of delaying social security: evidence from administrative tax data," Journal of Pension Economics & Finance 17, no. 4 (2018): 419-436.
7 Suzanne B. Shu and John W. Payne, “Life expectation judgments, fairness, and loss aversion in the psychology of Social Security claiming decisions,” NBER Working Paper onb13-05, National Bureau of Economic Research, (2013).
8 Jon L. Pierce, Tatiana Kostova, and Kurt T. Dirks, "Toward a theory of psychological ownership in organizations," Academy of Management Review 26, no. 2 (2001): 298-310.
9 Joann Peck and Suzanne B. Shu, "The effect of mere touch on perceived ownership," Journal of Consumer Research 36, no. 3 (2009): 434-447.
10 John W. Payne, Namika Sagara, Suzanne B. Shu, Kirstin C. Appelt, and Eric J. Johnson, “Life expectancy as a constructed belief: Evidence of a live-to or die-by framing effect,” Journal of Risk and Uncertainty 46, no. 1 (2013): 27-50.
11 Adam Eric Greenberg, Hal E. Hershfield, John W. Payne, Suzanne B. Shu, and Stephen A. Spiller, “Exploring How Uncertainty in Longevity Estimates Predicts SSA Claiming Decisions,” NBER Working Paper No. orrc17-09, National Bureau of Economic Research, (2017).
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