November 15, 2022
With rising inflation making the decision about when to claim Social Security benefits more important than ever, Vanguard’s research team revisited the optimal claiming strategies to see if changes should be made to account for expected or unexpected inflation.
As inflation continues to rise and the Federal Reserve’s attempt to contain it pressures the markets, late-career investors may be considering changes to their retirement plans. However, Vanguard research shows that one thing these investors shouldn’t change is their strategy for claiming Social Security.
Although high inflation can affect retirement outcomes, Social Security benefits remain inflation-resistant, with payments increasing to reflect the cost of living. Because higher inflation means greater benefit amounts, delaying the claiming of Social Security payments can make those benefits even more profitable, both in annual Social Security income for the retiree and in the bequest amounts they’re able to leave behind. The chart below illustrates the difference the right strategy makes when it comes to the best ages to claim Social Security.
Note: The strategies in the key show the male claiming age to the left of the slash and the female claiming age to the right.
“The claiming decision is one of the most important people will ever make because this single decision affects their benefit amounts for the rest of their lives,” said Boris Wong, Ph.D., a Vanguard U.S. wealth planning research specialist. “With higher inflation now and the expectation of high inflation in the near future, too, it was important to revisit whether people need to rethink their strategies.”
Vanguard researchers conducted two case studies using Vanguard Financial Advice Model (VFAM) analysis. VFAM incorporates Vanguard’s capital markets expectations, client goals, and cash flow projections to assess the attractiveness of different planning decisions, including when to claim Social Security. The analysis assessed outcomes for a hypothetical married male and female, both age 62, with a retirement spending goal of $50,000 per year and an expected Social Security primary insurance amount (PIA) of $2,000 for the male and $1,500 for the female, ranking nine claiming strategies from best to worst.1
The analysis compared the optimal strategies for our hypothetical couple based on Vanguard’s December 2020 forecast of an average 1.6% inflation rate increase per year over the next decade with one informed by our higher June 2022 forecast of a 2.5% increase.
Result: The optimal strategy remained unchanged, with the analysis recommending that the 62-year-old male delay claiming until age 70, while his wife should claim at 67.
The same couple’s claiming strategies were evaluated with the scenario of an inflation spike occurring after they made claiming decisions that had been informed by the 2022 forecast.
Result: As seen in the table below, the analysis showed that only the most extreme inflationary environments would change recommendations for the optimal claiming strategies.
Note: The bolded strategies indicate a change in ranking compared with the best strategies based on expected inflation. Percentiles are from the Vanguard Capital Markets Model.
IMPORTANT: The projections and other information generated by the VCMM regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Distribution of return outcomes from VCMM are derived from 10,000 simulations for each modeled asset class. Simulations as of June 30, 2022. Results from the model may vary with each use and over time. For more information, please see the notes.
The second column reports the optimal strategy for the hypothetical couple who choose their claiming strategy then live through three years of the 1,000 highest inflation paths of the 10,000 simulated by the Vanguard Capital Markets Model® (VCMM), the top 10% (90th percentile-plus) of all simulations. Although they confront annualized inflation of 6.4%, the couple’s optimal strategy remains mostly unchanged. The third column shows recommended strategies in the 50 highest simulated paths (99.5th percentile), with annualized inflation of 11.4%. Only at this extreme does the optimal strategy change.
Both studies show that inflation—whether expected or unexpected—has little impact on changing the best Social Security claiming strategies. So what does have an impact?
Wong said the main factors affecting Social Security claiming decisions are unrelated to the financial markets—the PIAs, the relative ages of investor, and their life expectancies. Financial advice that takes these personal factors into consideration can help investors make complex claiming decisions, thereby increasing value.3 “People should not make this decision lightly; rather, they should take the time to figure out the best claiming strategies for their personal situation,” he said.
1 The PIA is the benefit amount beneficiaries will be eligible to receive at their full retirement age (FRA). We assume that both members of the couple were born in 1960, which puts their FRA at 67.
2 We model the unexpected inflation surge over a three-year period. Over the full 10 years, we assume that inflation reverts to the longer-term expectation. For the 90th percentile simulation, this assumption results in 10-year expected inflation of 3.9%. For the 99.5th percentile, 10-year expected inflation is 5.4%.
3 See the case study on Pages 16 and 17 of the Vanguard research paper The Value of Personalized Advice for an example highlighting the value an advisor brings to Social Security claiming decisions.
Notes: All investing is subject to risk, including the possible loss of the money you invest.
IMPORTANT: The projections and other information generated by the Vanguard Capital Markets Model regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. VCMM results will vary with each use and over time.
The VCMM projections are based on a statistical analysis of historical data. Future returns may behave differently from the historical patterns captured in the VCMM. More important, the VCMM may be underestimating extreme negative scenarios unobserved in the historical period on which the model estimation is based.
The Vanguard Capital Markets Model® is a proprietary financial simulation tool developed and maintained by Vanguard’s primary investment research and advice teams. The model forecasts distributions of future returns for a wide array of broad asset classes. Those asset classes include U.S. and international equity markets, several maturities of the U.S. Treasury and corporate fixed income markets, international fixed income markets, U.S. money markets, commodities, and certain alternative investment strategies. The theoretical and empirical foundation for the Vanguard Capital Markets Model is that the returns of various asset classes reflect the compensation investors require for bearing different types of systematic risk (beta). At the core of the model are estimates of the dynamic statistical relationship between risk factors and asset returns, obtained from statistical analysis based on available monthly financial and economic data from as early as 1960. Using a system of estimated equations, the model then applies a Monte Carlo simulation method to project the estimated interrelationships among risk factors and asset classes as well as uncertainty and randomness over time. The model generates a large set of simulated outcomes for each asset class over several time horizons. Forecasts are obtained by computing measures of central tendency in these simulations. Results produced by the tool will vary with each use and over time.
Boris Wong, Ph.D.