Bridge the Gap – Social Security Bridge Strategy
Social Security Bridge Strategy: This comprehensive guide helps you Bridge the Gap to optimize social security. For many, Social Security optimization is an important component of retirement financial security. How can you pay for retirement before you turn on social security?
But first, is it worth it to delay social security?
Is it Worth it to Delay Social Security?
Delaying social security increases your income for life. Not only are the checks larger, there are also larger cost of living adjustments.
Using a Social Security Bridge Strategy makes sense if you can close the gap: after retirement, how do you pay for expenses while delaying social security?
Let’s look at how much is at stake by using a social security bridge strategy:
Full retirement age is 67 for those born after 1960. If you claim at 62 you lose 30% of your Primary Insurance Amount (PIA—the amount you get from social security at full retirement age). If you claim at age 70, you get 24% more than your PIA! So, you can get anywhere between 70% and 124% of your PIA depending on when you claim.
Assume your PIA is $1000: you can get $700 a month or $1,240 a month depending on when you claim. That is a 77% increase by delaying! And, cost of living adjustments are proportionally larger as well.
It can really make a lot of sense delaying claiming to increase your total net worth! Here is an example of the social security bridge strategy and total net worth over time.
Example of Total Net Worth with and without Bridge Strategy
Above, there are two strategies for social security clamming. In light green, you start claiming at age 62. You can see there is a slow increase in assets until about two decades later when inflation catches up with income.
Conversely, in dark green, delaying claiming until 70 causes an initial decrease in net worth. You can see with time, net worth increases given the larger social security income.
Note that the cross over point, the time when you have more net worth due to delayed claiming, is about age 86. This is a full 24 years after the earliest you can claim (age 62), and 16 years after the latest you can claim (age 70).
So obviously it is not right for everyone to delay claiming social security. So who should?
Who Should Delay Social Security?
If you might live beyond 85 year of age, consider delaying social security! There is no better longevity insurance than a delay in social security. Other annuities don’t come close to the power of delayed social security.
It is especially important in a couple for the high-income earner to delay as long as possible. This is due to the Widow’s Tax Penalty, where the lesser of the two social security checks stops at the death of the first spouse.
Finally, if you want to have a Tax Planning Window and have unfettered access to your 10 and 12% tax brackets to do partial Roth conversions (or capital gain harvesting), delay claiming as long as possible.
Will Social Security Still be Around when I’m 70?
This is an important consideration. Legislative risk is present with social security, and changes will be made in the next decades or sooner.
Generally, changes in social security are made in the distant future, and folks approaching retirement age are grandfathered in.
To me, it doesn’t make sense to claim early if you are worried about social security being solvent. Any changes will likely be on a percentage of what you are earning. Thus, if you claim early, you will have a percentage change on a smaller amount of social security rather than on a larger amount.
Next, how do you build your bridge to delay social security?
Social Security Bridge Strategy: “Bridge Assets”
How do you bridge the time after income stops and before social security begins most effectively?
Let’s look at some “Bridge Assets:” resources that are used to pay the bills while you delay claiming social security.
What are Bridge Assets?
Bridge Assets are resources, investments and strategies that allow you to live an active retirement until claiming social security at 70.
They are, in many ways, similar to Buffer Assets. These aspire to prevent Sequence of Return Risk, which is also an active concern of novice retirees.
Let’s modify a classification of Buffer Assets I developed and see how that works with Bridge Assets. The idea here is to generate a list of ideas to test on a fictional scenario.
- Flexible Cashflow—Income need in retirement is driven by expenses. You can control expenses or earn money, neither one is very much fun in retirement!
- Expense Modification: One can spend conservatively or have guiderails for spending
- Income Generation: Using human capital (a part to job or side gig)
- Additional Income: Income from rentals, patents or other passive income streams
- Investment Strategies—this is the mainstay of Bridge Assets.
- Ladders: “Ladders” of CDs, Bonds, or MYGAs. Consider laddering a combination of 2 or 3 of these assets depending on interest rates
- Goal Segmentation Strategies: Guaranteed fixed income “floor” provided through pensions, annuities or TIPS ladder
- Annuity Strategies: Income from immediate annuities, longevity insurance from deferred annuities, or period certain annuities during the delay years
- Income Portfolio: Preferred stock, dividend stocks, utility stocks, REITs, convertible bonds and MLPs are not infrequently used by investors for “bond-like” exposure and income
- Retirement Accounts: Traditional or Roth IRAs are tapped for income
- Income Replacement Funds: Also known as Managed Payout Funds
- Uncorrelated Assets
- Cash Reserve Strategies: Having a large cash reserve will bog down overall portfolio returns
- Classic Buffer Assets: Cash value life insurance and HECM (reverse mortgages) have low correlation to market returns and tax-free “income”
- Other Assets: Businesses, hobby collections, rental properties, or other assets can be sold for income
Now that we have thought of some ideas to test, let’s meet our fictional couple.
Case Presentation- Social Security Bridge Strategy
Consider a couple 62 and 58 years of age. They have a net worth of $1.2M and want to see what social security will add to their retirement. They both hope to live to 95.
Currently, $100,000 is in cash, $200,000 in a Roth, $300,000 in a brokerage account, and $600,000 in a traditional IRA. They have a 60/40 portfolio; stocks return 7% and bonds 3.5%.
They will spend $5000 a month in retirement (about 4% withdrawal rate). Inflation is 2% and healthcare starts at $5000 a year with 5% inflation.
Their PIA is $2000 and $1000 a month (so if they both claim at their full retirement age they will get $3000 a month in social security). The older partner was born in 1957, so his full retirement age is 66 years and 6M. The younger partners is born after 1960 so her full retirement age is 67.
Effect of Social Security Bridge
If they both claim as early as possible (age 62), they will start out with $18,000 a year, which increases to $28,000 a year when the younger partner turns 62. This increases by 2% a year in this model.
On the other hand, if they wait until 70 to claim, after 8 additional years they will make $36,000 a year which increases to $58,000 a year 4 years later.
See these numbers above above. In grey, they each claim at 62. In blue, 70.
Above you can see the different claiming strategies. Gray is early, blue is delayed.
The cross over point where they make more by delaying is at age 79 (15 years after retirement). If the younger partner lives until 90, they will earn $632,000 more over their lives with the delayed claiming strategy.
On Monte Carlo, early claiming has a 61% chance of success and delayed claiming 82%.
Let’s look at the portfolio total over time next.
Comparison of Portfolio Total with Social Security Bridge Strategy
Above, light green demonstrates early claiming. The total amount increases for about 20 years, and then gradually decreases. In blue bridge to social security at 70. Initially there is a draw down in the portfolio total. When they start claiming social security at age 70, the portfolio total slowly increases.
The cross over point, where delayed portfolio has more than the early, is at age 85, 13 years after retirement.
Good and dandy. So, with $60,000 in expenses a year, they can do pretty good if they delay claiming social security until age 70.
Some Options to Bridge Social Security
Goal Segmentation Strategies
In bucketing, you can have time segmentation (now, soon, and later) or goal segmentation. A good goal is to “cover” fixed (floor) income needs with guaranteed income such as social security, pensions, and annuities.
Delaying Social Security really is all about goal segmentation! Think about this: you need to cover certain expenses for a certain time period. The goal is to have income while you are growing your social security payment in the background. There is time segmentation as the income needs to last until you are able to tap into social security.
Additionally, the goal of finding income now for maximal social security later improves the guaranteed income for future fixed expenses.
Another way to guarantee income is with annuities.
Annuities are often mentioned as Gap Strategies, but I think they are mostly unsatisfactory for this purpose. If you have an expensive, complicated Variable Annuity or Fixed Indexed Annuity, you could consider making withdrawals from the annuity to fund a bridge. Don’t rush out and get one of these products, however, as they are expensive and complicated.
There are better products.
I cover single premium immediate annuities and deferred income annuities in excruciating detail elsewhere. A brief review of period certain annuities is in order in regards to Bridge Assets:
Annuities with Period Certain
Annuities with period certain are the most useful annuities in delaying social security. You can give a lump sum of money for a certain number of yearly payments. For example, currently a 5-year period certain will return 20.7% of the lump sum yearly for 5 years. For a 10-year term certain, you get 11.2% back every year for 10 payments. SPIAs with period certain certainly should be evaluated to cover income gaps of known duration such as you have when delaying social security.
I did test a few variations of SPIAs with period certain and did not improve Monte Carlo odds. Annuities cannot make more money out of thin air. For those who don’t like stock market risk, however, having an insurance company guarantee a fixed return for a certain number of years could be excellent planning.
Income Portfolio and social security bridge strategy
In your brokerage account, you can focus on total return or income. If you switch from total market funds to REITS, preferred stocks, high dividend stocks and the like, you will get more taxable income every year.
If you are funding your gap through the brokerage account (selling assets and paying capital gains), it is unlikely an income portfolio will have much of an effect. Increasing dividends from 2% to 5% (with total return still 7%) had no effect on the current scenario.
Consider, however, if you fund a gap through non-brokerage assets, an income portfolio provides some income without selling assets.
Uncorrelated Assets and Social Security Delay
Finally, we have reached uncorrelated assets. These are assets that don’t drop with the stock market. Perhaps a better word is less-correlated rather than uncorrelated, as everything goes down if the recession is bad enough.
Classic Buffer Assets
Named in honor of Dr. Wade Pfau, the originator of the term Buffer Assets. If you have cash value in a life insurance product, or a HECM (see below), “income” from these can be used to Bridge the gap.
Life insurance is a touchy subject. Aside from special needs trusts, estate tax issues, and perhaps leveraging life insurance if you don’t need your RMDs, there really is no need for permanent life insurance. Yet, it is often sold (rather than bought) and many people have cash value policies. If you have a permanent life insurance policy, a loan on the cash value is a non-correlated asset that can be used for income to prevent SORR or as a bridge to Social Security.
The home is often a large asset. Tapping the value of the home is an important consideration. Although most believe reverse mortgages are a last-ditch effort to save retirement, this needs to be reconsidered. HECMs are a type of reverse mortgage that can be set up at age 62.
Although not modeled in the current scenario, if you are going to run out of money at some point in the future, tapping home equity through a HECM early while you delay social security (rather than claiming early and tapping home equity when you otherwise run out of money) is almost always going to be a winning scenario.
Other Assets to Maximize Social Security
Other assets are important considerations. Business interest, hobby collections, rental properties and the like can be sold for an infusion of cash. These non-portfolio assets are important to keep in the back of your mind during retirement. If you have a stamp or coin collection you inherited from a grandfather, what a good time retirement is to attempt to monetize this, or donate it in order to do Roth conversions in the same year.
Social Security Bridge Strategy: Optimize Social Security
In general, social security is the best longevity insurance out there. If the higher-earner defers taking social security, you get cost of life adjustments on the guaranteed delayed retirement credits. As you may know, the surviving spouse gets to keep the higher of the two social security payments. In a couple, the odds of one spouse surviving into their 90’s is pretty good. Especially if you are rich and intelligent. You would not be reading this if you weren’t!
What is your bridge strategy to optimize social security?