Why Social Security Claiming Really Counts for Wealthy Clients

Advisors should pay close attention to marginal tax rates (and IRMAA thresholds) and withdraw strategically from traditional IRA accounts while also spending down tax disadvantage investments such as non-qualified bonds. 

The bridge period can present opportunities to sell investments at a lower capital gains tax rate — particularly highly concentrated investments that reduce a portfolio’s Sharpe ratio. 

There are important portfolio implications of delayed claiming as well. Consider the following example. A 62-year-old decides to forgo $20,000 of income for a year and funds spending from $10,000 of stocks and $10,000 of bonds from a 50% stock/50% bond $500,000 portfolio. 

If she had simply claimed early and received the $20,000 from Social Security, she would still have $250,000 in stocks. By bridging spending with investments, she now has $240,000 in stocks. This will affect her expected wealth by reducing the percentage of her portfolio that can be expected to earn a risk premium.

It is more accurate to think of delayed claiming as an investment. By waiting a year, she invests $20,000 of bondlike assets to receive a guaranteed lifetime income stream worth $33,151 (that’s a pretty good return on a safe asset).

Within her holistic portfolio that includes the value of future income streams, her fixed income allocation has just increased, although this value doesn’t show up on a brokerage statement. 

Further Considerations

An advisor needs to adjust her investment allocation outside of Social Security to reflect the increase in fixed income wealth generated from delayed claiming. An easy way to account for this is to simply fund spending from fixed income assets, or increase equity allocations in qualified accounts to account for the sale of non-qualified equity investments used to fund bridge spending. 

The mechanics are a little more complicated. Since guaranteed income is in fact safer than investments when used to fund spending in retirement (especially inflation-protected guaranteed income through Social Security), buying income through delayed claiming should result in an even higher optimal allocation to stocks.

Blanchett and I conducted a more in-depth analysis of the asset allocation implications of guaranteed income in a 2018 paper published in the Journal of Financial Planning. 

The ability to increase portfolio risk outside of Social Security is an added benefit to delayed claiming. An investor who delays claiming from 62 to 70 can increase their stock allocation by as much as 10% and face no greater risk to either income or legacy.

Working to eke out a few basis points of investment alpha is far more difficult than capturing alpha from delayed Social Security claiming. Claiming optimally not only increases expected financial resources, but also provides opportunities for tax-efficient planning and earning a higher return from investments.

Michael Finke is a professor and the Frank M. Engle chair of Economic Security Research at The American College of Financial Services,