How to mitigate behavioral biases in retirement planning
It turns out that the principles of behavioral finance aren’t limited to investment strategies. They can apply equally well to Social Security planning.
About 10,000 baby boomers will turn 65 every day for the next 14 years, and when they do they will have to navigate more than 2,700 rules on benefits claiming.
To help clients get the most out of their benefits, advisers need to look out for psychological biases that may lead to less-than-ideal outcomes, said two experts during Financial Planning’s webinar “How to guide clients on optimizing their Social Security benefits.”
TIMING IS EVERYTHING
Much of the Social Security Administration’s rules are aimed at deterring people from claiming benefits before they their full retirement age, said John Brenkovich, a CFP and the principal of Brenkovich Financial Management, a registered investment adviser in Mamaroneck, New York.
For instance, a client who wants to collect benefits and continue working will be subject to an earnings limit if he or she hasn’t yet reached the FRA, which is set at 66 for people born between 1943 and 1954, and 67 for those born in 1960 or later.
Any income above that limit will result in the SSA withholding a portion of the client’s monthly benefit payments, Brenkovich said.
By contrast, if a client waited until the FRA, no money would be withheld.
‘GRANDDADDY OF FINANCIAL BEHAVIOR BIAS'
Despite the obvious drawback of claiming early, many clients will be tempted to do so as soon as they turn 62, the earliest age at which they are permitted to file for benefits.
This is largely due to people’s natural propensity for negative thinking and extreme aversion toward loss, whether it is real or perceived, said Paul Norr, a CFP with Thousand Oaks, California-based Bucks County Financial Planning Group.
“We hate losses — it seems to be built in. Losing $100 feels twice as bad as it feels good to gain $100,” Norr said.
“When it comes to Social Security, people are afraid of losing money if they can’t have it right away," he said.
When clients hear that they will benefit from waiting until the FRA or even later until 70 so that they become eligible to receive an 8% delayed retirement credit, they tend not to register any of that, Norr said.
When clients hear that they can increase their monthly benefit by as much as 8% by waiting until their FRA or even later until 70, they tend not to register any of that. Instead, they focus on the 4 to 8 year loss in the meantime, says Paul Norr, adviser and contributor to Bank Investment Consultant.
Instead, they focus on the four- to eight-year loss in the meantime.
People put more weight on bad news than good. They are also prone to catastrophizing that “bad things could happen,” so money now always feels better than money later.
Norr recalled a time when a prospective client walked in with the opening line “It’s all going to hell.” This was followed by “I’m trading gold and silver; the stock market is going to crash; the government can’t be trusted so I need to get my Social Security ASAP!”
Although those concerns are all arguably valid, the greatest risk to this client was his own negativity, to which the client agreed, Norr said.
Clients who fall prey to these hardwired emotional traps may see dire consequences down the road and not just for themselves.
Once someone has decided to start collecting Social Security benefits, that decision affects the spousal benefits that his or her partner will be eligible to receive, Brenkovich said.
Under SSA rules, a person is entitled to 50% of a spouse’s benefits, as long as that spouse has filed for Social Security.
This is especially important for a spouse whose partner has died, after which he or she can collect survivor benefits, Brenkovich said.
When both members of the couple worked, the surviving spouse will get the higher of the two Social Security payments. If that turns out to be the payment of the deceased spouse and he or she claimed the benefits early, then the surviving spouse will get less as well.
The same logic applies in reverse.
“Claiming Social Security benefits is not just about maximizing one’s own payments. It’s also about what you’ll be leaving for your surviving spouse,” Brenkovich said.
TURNING LOSSES INTO GAINS
So what can advisers do to mitigate some of these behavioral biases?
For one, establish anchors, and start the conversation by defining 68 or 70 as the appropriate claiming age, Norr said.
Anchoring refers to our inability to ignore arbitrary numbers, he said.
Often, the first number that enters any discussion becomes the main reference point, even if it isn’t necessarily better or worse than other numbers. As a result, advisers should take the lead and instill a late retirement age in the client’s head right off the bat.
From there, try to present anything less than 68 to 70 as a monetary loss by spelling out how much the client would lose if they claimed at 62, 63, 64 or 65, Norr said.
“Use loss aversion to your benefit," he said.
EYES ON THE PRIZE
More importantly, advisers need to remind clients to focus on the end goal, which is to live out their best lives in retirement, Norr said.
At the end of the day, financial decisions such as when to claim Social Security benefits are only instruments to achieve that goal.
People become obsessed with arbitrary numbers such as 62 or 63, but most of the time claiming a few years later won’t be nearly as injurious as they expect, Norr said.
Therefore, it is up to advisers to share their past experiences and ease clients' fears.
“Most people do not care about the details related to Social Security or investing. They just want to live their lives to the best within their means,” Norr said.