In 1975, employer-sponsored retirement plans were mostly defined benefit (DB) plans, designed to pay retirees a fixed income for life. Some 70% of the private-sector workers covered by any kind of employer-sponsored plan were enrolled in a DB plan. In 2022, the figure was about 12% and falling.
Today, workers mostly participate in defined-contribution (DC) plans such as 401(k) and 403(b) plans. Workers and (often) employers contribute to these tax-advantaged investment accounts. At retirement, workers have a pile of assets that they can use to finance life after labor.
I prefer DC to DB plans. They’re better suited to a tumultuous economy that limits workers’ ability to qualify for benefits in a traditional DB plan. And unlike DB payments, the DC balance is an asset that a retired worker may be able to bequeath to family or charity. But an accounting of DC plans’ credits reveals a big debit: the absence of guaranteed income.
Guaranteed income and retirement happiness
Boston College and the Employee Benefits Research Institute find that retirees who can finance consumption with guaranteed income—DB pensions, Social Security, and perhaps annuities—are happier. But as DB pensions disappear, so does a contributor to retirement happiness. The Stanford Center on Longevity explores strategies to compensate for this disappearance by maximizing retirees’ income guarantees from Social Security and, to a lesser extent, annuities.
I won’t spend any time on annuities. No one buys them. Vanguard explains their potential benefits, but notes that “The prospect of trading a significant chunk of liquid wealth accumulated over a lifetime of labor for a contract with an uncertain payoff looms larger in people’s minds than in the models.”
I’ll focus instead on strategies to maximize income from Social Security—guaranteed income indexed to inflation and wage growth. As Teresa Ghilarducci, a professor at the New School for Social Research, told congress, “there is no better annuity deal than Social Security.”
Later claiming, greater benefits
Workers who’ve paid Social Security taxes for at least 10 years are eligible for benefits. They can claim these benefits as early as age 62 and as late as age 70. Early claiming reduces benefits; later claiming enhances them. This chart displays changes in the 2023 maximum monthly benefit at different ages. Note: This analysis focuses on individuals. Claiming strategies for couples are more complex.
Source: Social Security Administration
Workers who delay Social Security claiming from 62 to 67 receive a monthly inflation-adjusted payment that is 41% higher. Those who delay until 70 get 77% more. Put another way, the delay from 62 to 70 represents an annualized return of 7.4% per year. And the monthly paycheck generated by this delay rises with inflation for the rest of our lives. Most of us have no access to investments that provide similar risk-free returns.
Building a bridge
This math is the basis for a financial planning strategy known as the bridge. The idea: If we retire before 70, as most workers do, we use assets accumulated in 401k plans and other accounts to build a bridge to maximum Social Security benefits. Rather than claim benefits at 62 or 67, in other words, we use savings to fund our spending until we qualify for maximum Social Security benefits at age 70.
The cost and complexity of this bridge depend on a worker’s retirement age. A worker who retires at 68 or 69 needs only enough assets to build a footbridge–a Saturday-morning scout troop project in Valley Forge Park. A worker who retires at 55 must build the Verrazzano-Narrows–a suspension bridge across the New York Harbor, with cables and towers engineered to accommodate the curvature of the Earth.
This chart displays estimates of the assets necessary to build a bridge to maximum Social Security benefits. These estimates depend on three simplifying assumptions:
- Inflation assumptions: I assume that the cost of living will rise at 3% annually, consistent with its historical rate.
- Return assumptions. I assume that bridge assets earn an annual return of 5.30%, the return of the Vanguard Federal Money Market Fund on October 27, 2023.
- Use of Social Security assumptions. I assume that any Social Security payments will be spent, not reinvested. Some analyses assume that early payments can be reinvested at returns higher than those available from delayed claiming. Like many researchers, I’m skeptical. I ignore this possibility.
Bridge budgets
Workers who hang up their hard hats at 55 need almost $700,000 in savings to bridge the 15 years between their departure from the workforce and eligibility for maximum Social Security benefits, as displayed in the figure below. Those who retire at 67 need just $156,000. And those who retire at 70 need nothing. They’ve already crossed the bridge.
Source: Social Security Administration; author’s calculation
As workers and retirees lose access to guaranteed income, the value of delayed Social Security claiming rises. These delays aren’t cheap. But if we can build a bridge to higher benefits, we stand a better chance of financing life after labor.
— A. Clarke