Underestimating Longevity Can Be Costly

Encouraging older people to wait as long as possible before claiming Social Security benefits is common advice. After all, the longer you wait (age 70 is when the maximum level of benefits becomes available), the higher your monthly benefits check. Plus, in a married couple household, if the man was the higher earner, when he passes away, his wife would be able to switch to his higher benefit amount.

A new study further emphasizes the benefits of waiting. As reported in the Wall Street Journal, a Federal Reserve Bank of Atlanta study found that instead of claiming benefits at age 62, almost 90% of people who are currently 45 to 62 years old would be better off waiting until age 70. Doing so could boost the typical worker’s lifetime discretionary spending by over $180,000. When segmented by wealth, the lowest 20% group of 45-to-62-year-olds could see an increase of $110,000, whereas the highest 20% could see an increase of $290,000.

However, the study’s authors say less than 10% of retirees are likely to wait until age 70 to begin collecting benefits. Why is that? One reason is the complexity of sorting through the many different claiming strategies. Another is that, for about half of households, holding off on Social Security would require reduced spending as they wait.

A common misunderstanding

A third factor is confusion over the difference between “life expectancy” and “longevity.” Life expectancy refers to the average number of years people typically live from a particular age. Longevity refers to how long people might live if everything goes well. When running numbers with a retirement calculator, people usually use life expectancy as a guide. Even the Social Security Administration’s website uses that approach. According to another Wall Street Journal article, that has left many people “ignorant of their so-called longevity risk — the probability of living a very long time — and the complications that presents.”

To factor longevity into your planning, the American Academy of Actuaries and Society of Actuaries offers an online Longevity Illustrator. James Poterba, an MIT economics professor who studies retirement savings, provides an example: “If Joe and Jane are 65, have just retired, don’t smoke, and are both in excellent health, there is a 46% chance that at least one of them will still be alive in 30 years.” That means one of them has a decent chance of living to age 95, which stands in sharp contrast to commonly reported life expectancy numbers. Currently, life expectancy for a male infant is just 73 years; life expectancy for a female infant is 79 years.

It also differs from people’s own intuitive sense of how long they might live, perhaps conditioned by widely reported life expectancy numbers. According to a Michigan State University study, people systematically underestimate their chances of living to age 75 by 10% or more. “For example,” the Journal reported, “one year the 65-year-olds gave themselves a 67% chance of living 10 more years, but 78% were still around to take the survey 10 years later." It’s a phenomenon one research calls “survival pessimism.”

Perhaps if people better understood their chances of living a long life, more would wait longer before claiming Social Security benefits.

If you are now taking Social Security benefits, at what age did you begin and are you happy with your decision? If you have not yet claimed benefits, when do you plan to begin and why?

Image used with permission.