Purchasing an Annuity To Delay Social Security

Workers who delay collecting Social Security benefits when they first become eligible at age 62 until their full retirement age of 66 to 67 — or even until the benefits max out at age 70 — can expect to receive a higher monthly benefit.

However, for those who want to retire at 62 or before full retirement age, delaying Social Security might mean being without income for those gap years.

One option these workers can explore is rolling over a portion of their tax-deferred retirement accounts into an annuity so they can receive guaranteed monthly income throughout the gap years before their Social Security benefits begin.

Let’s take a closer look at the benefits of delaying Social Security, how to bridge the gap with an annuity and the pros and cons of the entire process.

Social Security is the backbone of many American’s retirement income plans, but taking it too early be detrimental to a sustainable plan. Annuities can act as a supplemental income source or bridge the gap between the retirement start date and the Social Security start date.

Stephen Kates, CFP®Principal Financial Analyst for Annuity.org

Stephen Kates, CFP® is a personal finance expert specializing in financial planning and education. He serves as the Principal Financial Analyst for Annuity.org, where he delves into industry trends to support consumers and financial advisors on wealth management, annuities, retirement planning, and investing.

How Does Social Security Work?

Social Security is a federal government program that pays benefits to workers who have retired, people with disabilities and the surviving spouses and children of workers who have died.

To collect Social Security retirement benefits, a worker must have paid taxes into the Social Security trust fund during their working years.

Individuals who qualify for Social Security retirement benefits can begin receiving checks from the government at 62. However, they can also choose to delay the receipt of those benefits until their full retirement age (between ages 66 and 67, depending on their date of birth) or even until they are 70.

The Benefit of Delaying Social Security

The longer you delay receipt of Social Security retirement benefits, the larger the monthly benefit you can expect to receive becomes. You achieve the maximum possible benefit amount by delaying until age 70.

For example, if Robert starts claiming Social Security benefits at 62, his monthly benefit will be less than if he had delayed until his full retirement age of 67. That payment amount at 67 will in turn be less than if he had further delayed receipt until age 70.

Despite the higher monthly amount Americans can earn by delaying retirement until their full retirement age or later, data shows that most start collecting Social Security retirement benefits at 62 — even though taking Social Security benefits at 62 instead of full retirement age can mean leaving as much as 30% of their potential benefit amount on the table. For those with a full retirement age of 67, that adds up to about a 54% reduction if collecting benefits at 62 instead of 70.

Why Do So Many Americans Take Social Security at 62?

According to Suzanne Shu, professor of marketing at Cornell University, reasons include misunderstanding the system (treating it like a 401(k) or IRA), fear that they will die before enjoying benefits if they don’t start as early as possible (a fear that is generally unfounded) and simple impatience.

Some may be laid off before their full retirement age. Others may get tired of work and call it quits. Certain emergencies — the disability of a family member, for example — may also necessitate early retirement. The desire to fulfill a long-buried passion like charity or mission work may spur some into early retirement.

In these scenarios, it’s easy to understand why taking Social Security early is tempting.

How an Annuity Can Bridge the Gap

Still, to maximize their retirement benefits, many people look for ways to delay collecting Social Security. And no matter their reason for leaving the workforce, they still need a source of income between retirement and receipt of Social Security checks.

Recently, a strategy has been proposed and increasingly employed which involves the annuitization of retirement accounts within those gap years. Since an annuity provides guaranteed income within a period of time (irrespective of market performance), the funds in a 401(k) or IRA can be partially or fully rolled over into an annuity to provide the retiring worker with consistent monthly income during the gap years.

With this strategy and the safety net of guaranteed income provided by an annuity, the retiring worker can more comfortably delay retirement until full retirement age or 70, thereby increasing their monthly Social Security benefits.

Suppose Robert has $80,000 in a 401(k) and he wants to retire at 67 (his full retirement age) instead of at 62 to get the extra 30% Social Security monthly benefit. He can roll over that 401(k) into a fixed annuity. With a fixed interest rate of 4%, Robert can expect a monthly income of $1,470.74 for the five gap years. And after those five years, he can start enjoying his higher Social Security benefit for the rest of his life.

Pros and Cons of Using Annuities To Delay Social Security

What are the pros and cons of using an annuity to bridge the gap years and delay Social Security?

Let’s start with the pros:

Higher Social Security Monthly Benefit

An annuity can help you delay Social Security, which will allow you to collect a higher Social Security benefit at full retirement age or 70. The extra amount earned can accumulate to a very significant figure depending on how long the retiring worker ends up living. According to Michael Kitces, head of planning strategy for Buckingham Strategic Wealth, those who delayed Social Security benefits until 70 and lived to 90 have earned the equivalent of a 5% real rate of return in what is essentially a government-backed bond. He equates this to the best long-term return money can buy (with less risk than Treasury Inflation-Protected Securities, bonds, immediate annuities and stocks).

Higher Cost-of-Living Adjustment (COLA)

A related advantage is that a higher Social Security monthly benefit means a higher cost-of-living adjustment (in absolute numbers). For example, while a 6% COLA on $1,000 will yield $60, it will yield $78 on $1,300.

But what about the cons? There are some, including:

The Advantage Depends on How Long You Live

Kitces, quoted above, showed that it takes about 22 years to achieve break even with delayed Social Security. That means the retiring worker will only start positively benefitting from the delay when they reach age 84. The SSA expects a male and a female who are currently 62 to live until age 85 and 87.4, respectively, after retiring at 67 (in five years’ time). Nevertheless, it is very possible that they won’t live beyond 84, in which case there is no advantage earned from delaying Social Security benefits. The challenge is that we cannot predict our exact life expectancy.

Loss of Control

Using one’s retirement funds to purchase an annuity to facilitate a Social Security benefit delay means exchanging what you (largely) control for what you can’t.

Fear

With a current imbalance between what is paid out from and what is received into the program’s trust fund, many Americans are concerned about whether Social Security benefits will continue as they are. Depending on how valid these fears are, exchanging all, or a significant part of, the funds in a retirement account for a system with question marks surrounding its future may not ultimately work out in the annuitant’s favor.

In the end, deciding whether to purchase an annuity to delay Social Security is a decision you must make together with your financial advisor. Their familiarity with your unique situation will qualify them to suggest the best path for you to tread.