The bonus retirees get from waiting to claim Social Security income benefits increases in two steps. These steps, originally created as a shortcut to simplify benefit calculations, result in differences as high as $10,000 in the incremental value of waiting an additional year to reach each new step.

Claiming before the valuable step-years can be a costly mistake. Workers who claim at full retirement age lose a significant amount of wealth by not taking advantage of the most valuable 8% one-year step increase.

A worker in 2022 who is eligible to receive $20,000 in Social Security income benefits at age 62 can increase her income by waiting to claim up to age 70. The percentage increase is 5% each year up to age 64. It steps up after her 64th birthday to 6 2/3% each year up to her full retirement age (67 for someone born in 1960). After reaching 67, the bonus steps up again to 8% a year until age 70. 

The delayed claiming income step formula is supposed to be actuarially fair. Because the government expects to make more stepped-up payments to a 63-year-old than a 68-year-old, the percentage increase from waiting an additional year is lower.  

In reality, the formula isn’t actuarially fair. The percentage increase from deferral should rise gradually each year instead of increasing at ages 64 and 67. These two steps mean that the gain from waiting an additional year is higher the first year of each step, and understanding how the amount varies presents a planning opportunity.

The actuarially fair value of delayed claiming can be calculated by taking the present value of the higher future income payments discounted at current rates for Treasury inflation-protected securities (TIPS), and then subtracting the year of income lost by delayed claiming. A 62-year-old who delays claiming to age 63 gives up $20,000 this year, but gets an additional $1,000 of inflation-adjusted income per year for the rest of her life. 

How long will she live? We can use mortality tables to estimate the value of future income. Each payment is then multiplied by the probability that she will be alive to receive the future payment. 

Social Security has its own (SSA) mortality table that estimates the lifespan of average Americans, but this isn’t relevant for most higher-income financial planning clients who live significantly longer. This means they’re more likely to be alive at age 90 or 95 to cash their Social Security check. The higher probability of being alive makes the higher income payment from delayed claiming more valuable.

The $1,000 increase in income is worth more than you might expect. A 62-year-old woman doesn’t just get an extra $1,000 each year as long as she’s alive (the 50th percentile of longevity for an average 62-year-old American woman is 88, and age 92 for a healthy woman using Society of Actuaries (SOA) annuity tables). She gets $1,000 adjusted for inflation each year, and the inflation adjustment for 2022 was a full 5.9% increase from 2021. 

At today’s TIPS rates, $1,000 of income adjusted for inflation in 10 years is worth $1,051 right now. Our retiree has a 90% chance of being alive to receive the payment in 10 years using the SSA tables, and a 94% chance using SOA annuity tables. Multiplying the value today with the probability of receiving the payment results in a present value of $988 for a healthy woman.

The formula used to calculate the income boost from delayed claiming was established in the 1980s based on mortality tables that don’t reflect improvements in longevity in recent years, particularly among higher-income Americans. Because the formula is outdated, the value of the future income payments is always higher than the one year of income given up unless the individual is in poor health.

At today’s TIPS rates, an average man earns $6,112 by waiting a year to claim after turning 62 according to calculations by David Blanchett, head of retirement research at PGIM. For a healthy woman, the benefit from delayed claiming is $13,151. Delayed claiming is one of the few financial planning strategies that provides a much higher benefit to women. Longer-lived Americans of both sexes also receive a larger increase in net present value from waiting to claim Social Security.

How much does a healthy woman benefit from waiting an additional year to claim at 64? Just $10,198, or about 22% less than waiting from age 62 to 63. But there’s an additional benefit to waiting until age 65, when the annual increase rises from 5% to 6 2/3%. The present value of delaying from age 64 to age 65 is $17,331. She gets a 70% increase in net present value by waiting an additional year because of the step. For an average man, the benefit increases from $3,354 to $8,388, or 1.5 times higher than the value of waiting from 63 to 64.

During the three years between an individual’s 64th and 67th birthday, the benefit continues to rise by 6 2/3% per year. This results in a gradual decline in the incremental benefit of delayed claiming. A 66-year old average man only gets a $1,194 increase in expected retirement wealth by waiting until his full retirement age (67) to claim.

If he waits an additional year following the new 8% annual step, he gets a $9,070 boost in wealth by waiting until his 68th birthday to claim. A healthy woman gets a $9,475 benefit delaying from age 66 to 67, but a remarkable $19,039 increase in lifetime wealth by waiting from 67 to 68. The second step from age 67 to 68 is even more valuable to all groups of retirees than the first step from 64 to 65.

Although most experts agree that far more Americans should delay claiming to age 70, the incremental benefit to delaying from age 69 to 70 is far more modest than the benefit from delaying in the year after full retirement age. For example, an average man sees only a $2,959 benefit from delaying between ages 69 and 70 (vs. $9,070 between 67 and 68) and a healthy woman sees a $12,033 benefit (vs. $19,039 between 67 and 68). 

It is important for advisors to remember that the decision to delay claiming Social Security is not the same as the decision to retire. Withdrawals from traditional IRAs before required minimum distributions kick in can be an efficient way to bridge the gap between retirement and initiating Social Security, resulting in greater retirement wealth and a more secure lifetime income.