The decisions about the optimal age for starting Social Security benefits are subjects of a number of recent papers. It is generally agreed that initiating or postponing benefits may have significant consequences, but there is less agreement on how to model the problem or measure its financial implications.
By law, benefits are paid only to live beneficiaries. Thus, the anticipated future benefits should be weighted by the recipient’s survival probability—the probability that the recipient is alive when the benefits will actually be received. Many published papers assume that benefits will be received “on average” throughout the recipient’s expected remaining lifetime and estimate the present value of Social Security benefits by discounting the cash flow through life expectancy.
This paper will show the preferred approach is to estimate the actuarial present value (APV), which weights each future payment by the probability that it will be received. Based on survival probabilities and life expectancy tables that are compiled by the Centers for Disease Control, the paper demonstrates that the present value through life expectancy approach overstates the APV by approximately 10 percent. Therefore, timing decisions that are not based on the APV are probably suboptimal.
Joseph Friedman, PhD, is a professor of economics at Temple University. He earned a PhD in economics from the University of California at Berkeley, and his MA in economics and BA in economics and statistics from the Hebrew University of Jerusalem. Professor Friedman joined Temple University in 1985 and served as chair of the finance department at the Fox School of Business for 4 years. Before joining Temple University, he held faculty positions at the University of Pennsylvania, Tel Aviv University, the Technion-Israel Institute of Technology, and Sofia University in Bulgaria. Before moving to academia, Friedman held research positions at Abt Associates, The Rand Corporation, and the World Bank.