Seniors can begin receiving Social Security at 62 or wait before applying in order to draw a larger amount. For example, a Social Security payment of $910 a month starting at age 62 becomes $1,300 starting at age 67. If a homeowner can't afford to wait before drawing more funds, she can take out a home equity conversion mortgage – the federal government's reverse mortgage program – to bridge the gap. Many retirement counselors, including me, have recommended that strategy.
But late last month, the strategy drew criticism from a highly reputable source: the Consumer Financial Protection Bureau, which said in a press release:
"The Consumer Financial Protection Bureau today issued a report warning older consumers about taking out a reverse mortgage loan in order to bridge the gap in income while delaying Social Security benefits until a later age. The CFPB report found, in general, the costs and risks of taking out a reverse mortgage exceed the cumulative increase in Social Security lifetime benefits that homeowners would receive by delayed claiming."
The federal agency responsible for consumer protection has performed a public service by raising this issue. In evaluating it, however, the organization makes the same fundamental mistake that I made, which is to formulate the same advice for everyone. I have since come to understand that sensible advice on this issue has to be borrower-specific. While the CFPB is right that delaying Social Security is a mistake for some seniors, there are many for whom it makes good sense. I will expand on this point below.
The CFPB's methodology is to compare the costs of a HECM to the cumulated increase in Social Security payments from the age of 62 to 85. Implicitly, it assumes that the borrower is planning to sell his house at some point within that period, and is therefore only concerned with his equity. The CFPB ignores seniors who intend to remain in their homes indefinitely. Further, the spendable funds available to the borrower do not enter the analysis at all, even though this is the major driving force inducing seniors to take out HECMs.
My colleague Allan Redstone and I recently completed the development of a general retirement model in which HECMs are included, along with other income sources including financial assets generating a return. The model allows the user to stipulate a desired monthly draw of spendable funds, with draws from the HECM or from the financial assets serving as residual sources, calculating the user's estate value in every month. It turns out to be the perfect tool for examining whether it makes sense to delay taking Social Security.
Consider a senior of 62 who has a nest egg of $450,000 yielding 4 percent, and a home worth $300,000 appreciating at 4 percent. Her only sources of spendable funds are Social Security, withdrawals from an investment account, and monthly payments from a HECM reverse mortgage, which continue for as long as she resides in the house. From these, she elects to draw $4,000 a month. Given these assumptions, we ran the model twice, once assuming that the senior took Social Security of $910 starting immediately, the other assuming that she took $1,300 beginning at age 67. We compared estate values (financial assets plus home value less HECM loan balance) at different ages, and we looked at how long the $4,000 payment lasted.
We found that the estate value was higher on the immediate $910 option at ages 70, 75, and 80. At 85, the estate values were the same. At 90, the value was higher on the delayed $1,300 option. We also found that with the immediate $910 option, the $4,000 payment lasted until age 90 1/2, at which point assets were depleted, whereas with the delayed $1,300 option, asset depletion did not occur until age 92. Our conclusion? If this borrower intends to remain in her house indefinitely, she should delay taking Social Security until she reaches 67. If she expects to move out of the house, she should take Social Security at 62.
The case described above is unique; no two seniors face exactly the same decision process. The best approach, therefore, is to avoid generalities and base advice on the specifics of each case. The CFPB would make an important contribution if its website offered means by which any senior could assess the Social Security timing decision – not to mention a host of other decisions – based on the specifics of her situation. As I noted earlier, I have a retirement calculator that does exactly that, which I would be glad to license to the CFPB for placement on its website at no charge. All it has to do is ask.
ABOUT THE WRITER
Jack Guttentag is professor emeritus of finance at the Wharton School of the University of Pennsylvania. Comments and questions can be left at http://www.mtgprofessor.com.