Why Social Security Benefits Require Careful Study

Program is often viewed as basic retirement plan but is far more complicated than most investments.

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BOSTON—Social Security benefits are often explained in simple terms. Most people begin benefits near the earliest claiming age, which is 62 years old. A smaller percentage understands that benefits will rise by about 8 percent a year every year between age 62 and 70. A still smaller percentage knows it's possible to take spousal benefits and divorce benefits in certain situations without reducing one's own benefits at a later date. The percentages of informed people get smaller and smaller as the program's increasingly esoteric features present more rarified choices.

Finally, we reach the smallest possible sliver of Social Security wisdom. His is Larry Kotlikoff, an unconventional economist and thinker at Boston University. And it may be true that no one else covets this spot. But Kotlikoff has amassed an awesome amount of Social Security knowledge. He has been working for years to cram this information into a software product that will do all the heavy lifting to help people without such knowledge get the most possible money out of their Social Security benefits.

Maximize My Social Security, which costs $40, is getting better with each iteration. And Kotlikoff is getting better, too, and he's somewhat of a celebrity. Thanks to a collaboration with Paul Solman, the money correspondent at PBS, Kotlikoff is known to a growing legion of viewers as the Larry behind Solman's "Ask Larry" feature. As Solman says in the introduction to the feature, "Larry Kotlikoff's Social Security original 34 'secrets,' his additional secrets, his Social Security 'mistakes,' and his Social Security gotchas have prompted so many of you to write in that we now feature 'Ask Larry' every week."

And while the regular Q&A has been going on for a long time, there is a seemingly inexhaustible supply of new and devilishly complex questions that Kotlikoff fields. "Yes, it's crazy complex," he said in a recent Ask Larry, "but this is what Uncle Sam has provided all of us for a basic saving system. Paul [Solman] thinks the complexity is pretty much inevitable; he and I argued about it some months ago, with Nobel Laureate Peter Diamond weighing in as well. But Paul may underestimate how infuriating the system can be, since he's got a friend, me, to tell him how to handle his Social Security decisions."

Further, Kotlikoff takes few prisoners when criticizing the lack of efforts to correct the program's long-run financial deficits. "The president was disingenuous or uninformed when, in the debate, he claimed the system just needs to be 'tweaked'," he said recently in the PBS feature. Social Security "is in worse long-term shape than when the Greenspan Commission 'fixed' it back in 1983, though Paul argues with me about this as well."

Beyond Social Security, Kotlikoff also has been playing for years with an online business to perform similar alchemy for the broader world of financial planning. His Economic Security Planner, or ESP for short, may never threaten more popular tools. Again, that's in large measure the result of an approach that does not shy away from complexity but tries to use simultaneous equations to provide accurate answers regardless of the enormous differences among consumers seeking financial planning assistance.

Many people advocate working longer, for example. Kotlikoff adds an insight about Social Security that makes continued employment even more attractive. After age 60, a person's wage earnings are no longer adjusted, or indexed, to align them with earlier years' earnings in helping determine benefit levels. Placing them into the program's lifetime earnings calculations (the highest 35 years are included) virtually guarantees that earnings after age 60 will raise a person's eventual Social Security benefits.

"Being smart about taking Social Security really does matter," he says in an interview in a Pakistani restaurant near his home in Boston. Other smart things, he adds, include homeownership. It may be a home to you, but to Kotlikoff, a home behaves like his favorite retirement investment of all time: an inflation indexed annuity. An annuity provides a stream of income. A home provides a stream of consumption services.

Such conservative holdings matter, he says, because "I think we're going to have high inflation at some point." As this happens, he expects a big move away from paper-based assets such as bonds, and into real estate.

Kotlikoff's ESP also factors in state-specific living costs and taxes to help a person build the best planning and spending program. In the process, he doesn't exactly endear himself to 401(k) and other retirement managers. "We treat investing in stocks as going to the casino," he says. A major question for retirement planning thus becomes, "when do you want to start taking your assets out of the casino and put them into safe assets?"

Safe assets do not make a bundle. They provide inflation-adjusted returns that won't go away and on which people can build solid retirement spending plans. Because Kotlikoff is interested in helping people afford the best possible standard of living with their assets, these defensive holdings are a virtue in his mind. "We're not really talking here about retirement security," he explains. "We're talking about living standard security."

Twitter: @PhilMoeller