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How to juice Social Security if you claim before 70

Most workers don't maximize their Social Security retirement benefits by waiting to claim at age 70.

Yet that doesn't have to stop people who retire before 70 from receiving as much in retirement benefits as those who waited to receive the maximum amount, according to research by Eva Levine, an estate lawyer and certified financial planner at Plenaris Advisory in San Jose, California.

Claiming Social Security at 70 "looks good on paper, but is not practical for many people," Levine said. (See chart below.)

In many cases, retirees would be better off claiming Social Security at full retirement age and investing the benefits than waiting to claim until 70, Levine said. Full retirement age ranges from age 66 to 67, depending on your birth year.

The two most promising strategies Levine outlined in her research were to invest Social Security benefits claimed at full retirement age into variable annuities and indexed universal life policies.

The major drawback to these scenarios is that retirees would have to fund them with all the Social Security benefits received from 66 to 69, presumably living off other income and retirement savings in the meantime until they hit 70. The end result would yield higher total benefits in your 70s, 80s and 90s if the insurance products performed as Levine assumed.

"The best annuity on the market to protect against outliving your money is to delay taking Social Security payments." -Allan Roth, founder of Wealth Logic

Variable annuities and indexed universal life policies are complicated products that can carry high fees and surrender charges if investors want to back out of their contracts early.

Instead of buying expensive guarantees from insurers, more people should wait to claim Social Security benefits at 70, said Allan Roth, a certified financial planner and founder of Wealth Logic in Colorado Springs, Colorado.

People who wait to claim Social Security at 70 receive an estimated 40 percent discount to the cost of replacing those benefits with an inexpensive deferred annuity, Roth said.

"The best annuity on the market to protect against outliving your money is to delay taking Social Security payments," he said.

Investors should review variable annuities and indexed universal life policies carefully before buying. A financial advisor who is a fiduciary can help you with the evaluation.

A variable annuity is an insurance contract where your payouts are based on the investments you select. These annuities are tax deferred, which means you don't pay taxes on the income and investment gains until you make a withdrawal.

Indexed universal life policies credit a tax-deferred account based on the performance of one or more market indexes, such as the S&P 500. These policies have a guaranteed growth rate and offer downside protection when the index generates losses.

Here's how the downside protection works: Let's say the S&P 500 drops 2 percent in a year, indexed universal life policyholders would not see the value of their accounts diminish. The trade-off is that such policies put a cap on how much the account can be credited if the market gains.

If you claim Social Security retirement benefits at age 70, you generally will not receive more benefits than someone who claimed at full retirement age until after you reach 80. Using insurance products to boost Social Security benefits claimed at full retirement age can reduce the risk of dying before you reap the full benefits of waiting to claim at age 70, Levine said.

"My approach is to help my clients get more clarity so they know exactly what to expect," she said.

Rosy assumptions

As with any investment projection, assumptions matter. Levine assumed that the typical annuity investor would generate an average annual return of 5 percent after fees and an index universal life policyholder would earn 6 percent a year after fees.

The growth rate for U.S. stocks is expected range from 4 percent to 6.5 percent annually over the next 20 years, according to a recent report from the McKinsey Global Institute, which Levine cited in her research.

"Five percent is a relatively conservative growth rate and is within the current expected range of return considered to be reasonable by the financial industry," Levine said.

Earning a steady 5 percent annual return from variable annuities may not work out for many investors.

"The common challenge of using deterministic returns — 5 percent static return year in and year out — is that there is no consideration for the real world and the likely randomness that will be experienced," said Kevin Loffredi, senior product manager of annuity solutions at Morningstar.

Even if a 5 percent expected return is reasonable, Levine underestimates the average cost of variable annuities.

The typical variable annuity is loaded with fees. The administration and distribution fees can be as high as 0.6 percent annually. The underlying investment subaccounts have fees that range from 0.28 percent to 3.26 percent annually. The average subaccount charges 0.97 percent annually, according to Morningstar.

On top of all those fees, variable annuities have onerous surrender charges that range from 7 percent to 9 percent and decrease each year that the contract is in force until they reach zero.

Levine used a low-cost variable annuity from Jefferson National in her calculations that showed investors could use the product to generate as much benefit payments as those who waited to claim Social Security at 70. Jefferson National charges a flat annual fee of $240 and 0.05 percent to 0.35 percent annually for certain subaccounts. The insurer has a B+ rating from A.M. Best, meaning it has a "good" ability to meet its financial obligations.

"I do not like the usual variable annuity and I never use it," she said. Levine said she prefers the variable annuity from Jefferson National because it offers lower than average fees.

Here's how the simplest scenario Levine evaluated worked with a variable annuity:

Let's say an individual beneficiary receives $30,000 per year in Social Security retirement benefits at age 66 with a 3 percent cost of living adjustment and is taxed at a 28 percent federal income tax rate.

If that person lives to age 100, they would receive a total of $1.38 million in Social Security benefits. If that person waited until age 70 to claim, they would receive nearly $1.7 million in Social Security benefits if they lived to 100.

If that person invested the first four years of their Social Security benefits they claimed at age 66 in a low-cost, tax-deferred annuity that returns 5 percent a year, they would have a total of $1.87 million in benefits at age 100.

Levine's strategy would generate roughly $174,000 more in benefits than if a person claimed Social Security at 70. It also would produce more income for this hypothetical individual in their 70s, 80s and 90s.

However, investors who want to replicate Levine's strategy will have difficulty producing similar outcomes if they used a variable annuity with average fees. They would also need to fund their retirement between 66 and 70 with another source of income or retirement savings.

If the variable annuity's average annual return fell below 3.5 percent, the person who claimed Social Security at 66 would have a lowered level of payouts than the person who claimed at 70.

Levine's assumptions about indexed universal life policies are aggressive, too.

An expected 6 percent annual return from an indexed universal life policy is "not logical," said Lawrence Rybka, president and CEO of ValMark Securities, an independent broker-dealer in Akron, Ohio, with a large insurance business.

The way indexed universal life policies credit policyholders' accounts for equity returns do not include dividends from stocks, which have historically contributed as much as 35 percent of total returns, Rybka said. That makes achieving the 6 goal harder for policyholders.

"The 6 percent return I use is lower than the 7 percent average rate that most insurance people use to illustrate [an indexed universal life] policy," Levine said.

The point of her research was to compare the benefits of claiming Social Security at full retirement age with claiming at age 70, Levine said. She did not want "to identify the best investment option for a retiree because it is really contingent on the personal attributes of each retiree."

So if you want to juice the Social Security benefits claimed a full retirement age, tread carefully before you follow Levine's strategy. Otherwise, you can always claim Social Security at 70.