Is There a Case for a Social Security Bridge Option?

Retirees face a difficult job figuring out how to draw down their 401(k) and often claim Social Security the earliest they can, but a new white paper suggests that a “Social Security bridge” could be a helpful solution. 

In “How Best to Annuitize Defined Contribution Assets?,” Alicia Munnell, Gal Wettstein and Wenliang Hou of the Center for Retirement Research at Boston College argue that using a portion of their 401(k) as a “bridge” to delay taking Social Security provides the best outcome for households in the middle of the wealth distribution scale and remains competitive for those at the 75th percentile of the wealth distribution. 

Moreover, they contend that introducing such an option as the default in 401(k) plans would require no legislative or institutional changes, and would enhance the welfare of plan participants.

As part of the study, the authors evaluate how various approaches—including immediate annuities, deferred annuities, and the Social Security bridge—compare, assessing each one in terms of “utility equivalent wealth” that would be required to achieve the same utility under one strategy relative to another. Workers could use a portion of their 401(k) and IRA assets to purchase an immediate annuity, purchase an advanced life deferred annuity, or “buy” additional Social Security annuity income.

While most policy discussions focus on commercial annuity products, the paper explains that another option is to use a portion of defined contribution wealth to buy more annuity income from Social Security by delaying claiming. Most workers currently claim Social Security benefits before age 70 and, as a result, receive reduced amounts. In fact, monthly benefits claimed at 70 are at least 76% higher than those claimed at 62, the authors note. 

As background, the CRR paper suggests that introducing a default into 401(k) plans that would use 401(k) assets to pay retiring individuals ages 60-69 an amount equal to their Social Security Primary Insurance Amount (PIA)—the monthly amount an individual would receive from Social Security if he claimed at his full retirement age. 

“The expectation is that providing a temporary stream of income to replace the Social Security benefit would break the link between retiring and claiming,” the Munnell, Wettstein and Hou write.  

Another advantage, they contend, is that the approach would not require any new bureaucratic structure or involve contracting with an insurer. And since the approach does not formally include buying an annuity, it may sidestep the resistance that annuity products have garnered among the public, they further argue. That said, while the paper suggests that a Social Security annuity is not subject to the insolvency concerns that apply to commercial annuities, which, the authors note, have been a major obstacle to their inclusion in DC plans, they do not address concerns about the solvency of the Social Security program. 

As for the overall results, the study found that for both single men and single women, purchasing an immediate annuity produces a better outcome than no annuitization, and annuitizing 40% is better than annuitizing 20%. The authors note that this finding is consistent with the literature, showing that substantial annuitization is generally desirable.

But using a portion of wealth to defer Social Security claiming is preferred to purchasing an immediate annuity due to the advantageous features of Social Security, the authors suggest. As in the case of an immediate annuity, annuitizing a larger share of wealth requires less initial wealth to achieve the same level of utility. The results for the deferred annuity are mixed, however. 

According to the analysis, the option that involves the drawdown based on required minimum distributions (RMD) produces a worse outcome than no annuitization, reflecting the fact that households withdraw suboptimal amounts between ages 65 and 85. By contrast, the deferred annuity option that assumes households withdraw all their assets over the age period 65-85 produces an outcome similar to the immediate annuity. “The bottom line is that, for the median household, the Social Security bridge option is the clear winner,” the authors suggest.  

For households at the 75th percentile of wealth (approximately $250,000 for a single-person household), the study finds that at such wealth levels, allocating 20% of assets is sufficient to delay claiming almost to age 70. “For these higher-wealth households, the deferred annuity strategy is again competitive, edging out the Social Security bridge option, as the income derived from this annuity after age 85 provides enough of a buffer so that even if a health shock hits, consumption does not fall to very low levels,” the paper states. 

That said, if following the RMD remains the rule of thumb for retiree withdrawals, the deferred annuity remains a poor choice, for both median- and 75th-percentile-wealth households, the authors emphasize.