A new idea for solving Social Security's money troubles

Wharton professor Olivia S. Mitchell sat down to discuss a new idea to help solve the Social Security deficit. In "Will They Take the Money and Work? An Empirical Analysis of People's Willingness to Delay Claiming Social Security Benefits for a Lump Sum," Mitchell and her colleagues argue that lump-sum payouts serve as an incentive to put off collecting Social Security.

Here's the difference:

Start at 62, get monthly payments the rest of your life.

Delay until 67, get a lump sum equal to what you would have collected during those five years and monthly payments thereafter.

What is the Social Security lump-sum payment idea?

Deciding when to claim Social Security benefits is the most important financial decision that many households make. People can claim as early as age 62, as late as 70, or in between. It isn't widely appreciated, however, that claiming early leads to much lower monthly benefits, while delaying claiming until age 67 boosts your benefits by 43 percent - for the rest of your life. Nevertheless, most Americans claim benefits well before age 70.

Our research explored whether more Americans would delay claiming if they could get their increased Social Security benefit at a later age in the form of a lump sum, instead of a higher benefit for life.

Specifically, we asked how much later each person would claim if he or she were offered the "age 62" monthly benefit - plus a lump sum that would grow the longer they waited to claim Social Security. This lump sum was computed as "actuarially fair," meaning equal to the present value of all future benefit increases under the status quo.

How big are the lump-sum inducements?

For instance, someone who would get $1,500 per month if she claimed at age 62 would get that same $1,500 plus $108,000 if she claimed at age 67.

What does your research show about how lump sums would affect people's decisions?

We found that many people would voluntarily claim later, and work longer, if they could get lump sums, plus benefits of this amount. Interestingly, those who would delay were the same people who intended to quit working earliest under current rules.

Our results suggest early retirees are not all forced to retire, but instead could, with the right incentives, remain in the labor force longer.

In a nutshell, we set out to design a way to give people benefit increases if they delayed claiming, but instead of a monthly payment, give it to them as a lump sum at their later claiming date.

The money turns out to be quite substantial, from $60,000 to $80,000 and up to $170,000.

How much money would be saved by Social Security if Americans could adopt the lump-sum option?

Our experiment focused only on "fair" lump sums, so we'll have to do more research to figure out whether people might be willing to take less to get a partial Social Security buyout. But a recent study of public school teachers found that employees were willing to pay only 20 cents on average for a dollar in lifetime pension payments.

Would offering lump sums be good for society, even if it could enhance Social Security's balance sheet?

Many Americans suffer from financial illiteracy, so one might worry that people would waste their lump sums and be left with nothing.

This is why we did not recommend allowing people to get their entire benefit paid out all at once. Instead, we argued that retaining the age 62 benefit for delayed claimers would be helpful in providing a floor of protection.

Presumably, those worried about how to spend the money could get help from financial advisers who would need to take retirees' best interests into account.

What role does Social Security's pending insolvency play? Is your proposal also a way to get people thinking about the system?

The U.S. Social Security system is a pay-as-you-go system, that is, payroll taxes collected from today's workers mostly go to pay today's retirees.

The problem is that, as our population ages, fewer young workers are paying into the system relative to rising numbers of ever-longer-lived retirees drawing benefits. So the reality is that the American Social Security system already confronts insolvency . . . it cannot afford to pay all the benefits it has promised. In other words, past and current Social Security participants have been promised far more in benefits than they will pay in taxes over their lifetimes.

We believe that a lump-sum buyout can be part of the answer in Washington. It could also be useful in Philadelphia, which also faces a deeply worrisome public pension shortfall.

earvedlund@phillynews.com

215-854-2808@erinarvedlund