Potentially millions of retirees missed out on up to $250,000 in retirement, according to a recent study, because of this one “major financial mistake.”
More than 1 in 6 retirees report getting income from Social Security and a private annuity. But had these retirees taken the lump-sum option for a pension rather than the annuity option or avoided buying a private annuity, they could have used the cash to delay taking their Social Security benefits to age 70.
The result: Depending on their age and earnings, the savings could have been in the tens of thousands to hundreds of thousands of dollars, according to the study from Stanford and George Mason University researchers. For the highest earners, that could amount to $250,000 extra, the authors wrote.
“Despite these various rationales for the strategy of claiming Social Security early when a household has a market-based annuity, our own reading of the situation is that these households are making a major financial mistake and leaving big money on the table,” the study authors wrote.
The study echoes traditional retirement advice from financial experts: Delay your Social Security until age 70 and get 8% more in monthly payouts.
But postponing Social Security may be difficult when the average baby boomer’s retirement savings may only last 7 years without curbing their spending. And that’s just those who have retirement savings. A study from the Insured Retirement Institute found that about 45% of boomers had no savings at all.
Here’s how the strategy proposed by the researchers would play out, according to Brent Weiss, co-founder at Facet Wealth, a financial firm.
“Assume you have one annuity that requires an investment of $100,000 and pays you $5,000 a year, but another that requires an investment of $100,000 and pays you $10,000 a year,” Weiss said. “In this scenario, the first is more expensive as you have to pay more money to receive a dollar of income, and therefore what if you could sell one and instead buy option 2?”
Option 2 is essentially living off the $100,000 and its investment returns while postponing Social Security benefits until 70 to get the larger benefit.
Overall, pension plans and private annuities purchased through insurance companies are more expensive compared with delaying Social Security, the study researchers found. They both require larger investments upfront for less income.
But the strategy still comes with risk if retirees end up living for a shorter period than expected and never realize the full benefits of postponing Social Security.
“If you can tell me when you are going to die, I can tell you the exact time to claim Social Security,” Weiss said. “Arbitrage strategies are great for optimizing for income in a vacuum. Unfortunately, living life to its fullest isn't always about optimizing around money.”