Leaving Big Money on the Table: Arbitrage Opportunities in Delaying Social Security

Recent research has documented that delaying the commencement of Social Security benefits increases the expected present value of retirement income for most people. Despite this research, the vast majority of individuals claim Social Security at or before full retirement age. Claiming Social Security early is not necessarily a mistake, as delaying Social Security commencement requires forgoing current income in exchange for future income. The decision to claim early could therefore rationally be driven by liquidity constraints, mortality concerns, bequest motives, a high time discount rate, or a variety of other preference related factors. However, for some individuals, delaying Social Security offers a significant arbitrage opportunity because they can defer Social Security and have higher income in all future years. Arbitrage exists for most primary earners who either purchase a retail-priced annuity or opt for a defined benefit annuity when a lump sum payout is offered, while forgoing the opportunity to defer Social Security. These individuals are essentially buying an expensive annuity when a cheaper one is available, and their decision to claim Social Security early is almost certainly a mistake. The magnitude of the mistake can reach up to approximately $250,000.