Linking Social Security reform with Private Saving Reform

Increases in the eligibility age for Social Security benefits need to be phased in slowly to prevent financial shocks to households nearing retirement and coupled with new policies that increase savings by younger adults. This post considers how a gradual change in Social Security benefits could be attached to proposals that promote increased private saving.

Introduction:  One approach being considered to expand the lifespan of the Social Security Trust fund involves increases in the eligibility age for receipt of the minimum and full retirement benefit.  This approach would result in substantial improvements in the financial condition of the Trust fund.  It would both increase revenue by forcing people to work longer and would delay outflows from the Trust fund.  It would reduce the future debt to GDP ratio and reduce the likelihood of future increases in taxes to pay off debt.  

However, there are adverse impacts and limitations associated with increases in the eligibility age for Social Security benefits.

First, most current retirees are highly dependent on Social Security.  (A study based on data from the Current Population Survey reveals 52 percent of older households receive more than half of their income from Social Security and a third receive more than 75 percent of income from Social Security.)  Workers currently nearing retirement could not be expected to substantially increase their savings to prepare for the increased retirement age. 

Second, A phased in increase in the retirement age would not prevent project automatic reductions in Social Security benefits associated with reduced Trust fund reserves.

Third, many workers when they near the eligibility age for Social Security benefits need to retire or need to reduce the hours, they work because of health concerns.  Health related problems impacting older workers will impact both current workers nearing retirement and future cohorts of workers. 

Fourth, younger adults are having an extremely hard time saving for retirement.  Student debt is at a record level and continues to climb with college cost and many young adults with high student debt burdens are either delaying saving for retirement or disbursing funds in retirement accounts early in their careers to meet current obligations.  A discussion of the use of pre-retirement funds prior to retirement can be found here.  In addition, young workers must save more for retirement than previous retirees because they are less likely to have access to a traditional defined benefit pension plan.

Changes to Social Security retirement benefit formulas need to be implemented gradually to avoid an abrupt economic shock impacting people nearing retirement and need to be linked with changes in savings incentives and economic reforms which facilitate increased private savings for retirement.

Increasing the eligibility age for Social Security Benefits:  Under current law, workers initially become eligible to claim Social Security retirement benefits at age 62.  People born after 1960 are eligible for the full Social Security retirement benefit at age 67.  The largest possible Social Security benefit is received by people who delay claiming until 70.

Changes to three parameters – the initial eligibility age for Social Security benefits, the eligibility age for the full benefit, and the age where people receive the maximum allowable benefit – are considered here.  The proposed changes would start five years after enactment after legislation.  The three retirement age parameters would increase by one month every two years until all three retirement ages increased by two years.  After the full enactment of the increased retirement age, the minimum eligibility age would be 64, the age of full benefits would be 69 and the age of the maximum benefit would be 72.

When the Social Security eligibility age is phased in many recipients will receive two fewer years of benefits over their lifetime.  

The phased in benefit reductions put the United States on a more favorable and sounder fiscal trajectory. These benefit reductions will reduce the future debt to GDP ratio.  However, the phased in adjustments do not prevent the automatic reductions in Social Security, which are current projected to occur in 2034.  The prevention of the automatic benefit cuts requires some other action by Congress.

One approach to deal with the automatic benefit cuts would involve the use of general tax revenue, which would lead to higher annual budgets. The projected future debt to GDP ratio is a more important measure of fiscal health than annual budget deficits because markets are forward looking, hence the prospect of lower future debt levels will restrain interest rates even if deficits rise in the short term.

The avoidance of projected automatic cuts to Social Security will also require some additional revenue from an increase in the payroll tax or some other tax.

The phase in of these changes would have to be slow to avoid financial shocks on people nearing retirement and to allow for increased private savings. The slow phase of the benefit changes allows for people to increase retirement savings prior to retirement. Younger adults will experience the full brunt of the change in the Social Security eligibility change but will also have more time to take advantage of reforms that will facilitate increased private savings.

Facilitating increased private savings:  Since most households nearing retirement age will be highly dependent on Social Security and most younger households have either delayed or reduced saving for retirement to meet current needs the proposed increase in the eligibility age for Social Security benefits must be accompanied by policies that lead to increased savings for retirement. 

The first set of policy proposals involves direct improvements to savings incentives and investment vehicles offered by investment firms.  The proposed changes in tax incentives and financial rules favor households which are currently having a difficult time saving for retirement, including people without access to the most generous employer-sponsored and people reducing retirement savings because of medical expenses.  The new tax and financial rules will provide incentives for workers to start saving for retirement at a younger age.

 Modifications to Direct Savings Incentives and Rules:

Tax and pension rules should be changed to equalize savings opportunities for workers dependent IRAs and 401(k) plans

  • Currently, higher income taxpayers will receive a higher tax savings from a 401(k) contribution than a low-income taxpayer.  This disparity would be eliminated by replacing the tax credit for contributions to retirement plans with a tax credit.
  • Current tax law allows employers to match employee contributions to 401(k) plans but does not allow for matching contributions to IRAs.  The rules should be changed to allow employers to contribute match employee contributions to IRAs as well as to 401(k) plans.
  • Tax law could be changed to allow firms to provide tax free contributions to retirement accounts of gig employees.  
  • Current limits on employee contributions to IRAs are lower than contributions to 401(k) plans.  These contribution limits should be equalized.

Improve the automatic 401(k) enrollment option and create a similar automatic savings option for firms that do not offer a 401(k) plan.  

  • The newly enacted automatic 401(k) enrollment option allows for firms to automatically enroll workers in 401(K) plans that charge high fees or have few investment opportunities.  The government could improve investment outcomes and increase wealth at retirement by limiting fees and by requiring access to low-cost or zero-cost investment options like direct investments in Treasury securities.
  • Automatic enrollment into IRAs or savings through Series I savings bonds should be created for workers employed at firms without a 401(k) plan.  The new automatic enrollment provision would be patterned after the 401(k) automatic enrollment provision, which allows workers to opt out of the automatic contribution and sets the initial contribution at 3 percent of income.  The expanded automatic enrollment provisions create an incentive for younger adults to either open an IRA or some other savings vehicle.  (Most young workers do not have access to a firm-sponsored retirement plan or are subject to vesting requirements.)   The initiation of saving at a younger age is a crucial reform needed to assure increased wealth at retirement.

Create rules that prevent use of all retirement fund prior to retirement and encourage workers to reduce leakages of funds from retirement accounts.

  • Current tax laws allow for investors to disburse all savings from a 401(k) plan or IRA prior to retirement.  (Disbursement rules are complex and often involve payment of tax and penalty.)  A new rule might prohibit pre-retirement disbursements greater than a certain percent of contributions, perhaps 50 percent of contributions.
  • Many young workers automatically disburse all funds contributed to a retirement plan at their first permanent job.  The default option for 401(k) funds during job transfers should be automatic transfer to a low-fee independent account. The worker who wants to maintain retirement savings at her old employer or withdrawing funds from an existing account would have the option of opting out of default arrangement.

Modify tax rules governing Flexible Savings Accounts (FSAs) and Health Saving Accounts to allow for increased savings.

  • Current rules governing FSAs result in the FSA owner losing any unused funds in the account at the end of the year.  A change in FSA rules that allows unused FSA funds to be rolled over into a 401(k) or an IRA would encourage greater contributions to FSA accounts and increase retirement savings.
  • Current rules only allow people with qualified high deductible health insurance plans to contribute funds to a health savings account. A change in these rules to allow for health savings account contributions for people with a wider variety of accounts could expand savings for health care and for retirement.   The new rule could lower rate of depletion of funds in the health savings account or increase contributions to retirement accounts since health savings accounts are often funded by decreased contributions to retirement accounts.

Expand investment opportunities in 401(k) and 529 college savings plans to allow for direct investment in Treasury securities including Series I Savings bonds and the tax-free conversion of 529 assets to 401(k) plans:

  • Many retirement plans and virtually all College Savings 529 plans allow for investments in a few fixed-income and equity funds and do not allow for workers to purchase bonds with a specific maturity date.   These bond funds, even those with short maturity assets fall in value when interest rates rise.  Investors should be given the option of holding Treasury securities to maturity when they will be guaranteed access to the initial bond purchase and all interest.
  • Rules should require retirement plans to provide access to all Treasury bonds including Series I bonds and Treasury Inflation Protected Securities (TIPs).  Access to these investments would reduce loss of wealth from fees and reduce portfolio risk.  
  • Current law taxes disbursements from 529 plans not used for educational purchases.  Workers should be allowed to convert part of the unused 529 plans to a 401(k or IRA without paying tax.  (Typically, the 529 contribution is exempt for state tax but not exempt from federal tax.  Since the initial contribution to the 529 plan was subject to federal tax the loss of federal tax revenue from this proposal might be modest.) 

Removal of Impediments to Saving for Retirement:

Many people fail to save for retirement because they get caught in a spiral of debt and live paycheck to paycheck for a prolonged period.  Often young adults delay saving for retirement or even raid their retirement plan to maintain their student debt payments. Roughly 9 million borrowers over the age of 50 are still making payments on their federal student loans and are having trouble meeting expenses in retirement.  

Other households, especially people with employer-based health insurance often lose health insurance during job transitions.  A loss of health coverage and increased medical debt exacerbating disruptions in the process of savings for retirement routinely occur during recessions.  

A second set of policy initiatives attempts to remove impediments to saving experienced by people who have high student debt or lose health insurance during job transitions.

Implement policies to reduce student debt burdens to facilitate increased savings for retirement.

  • Many of the most vulnerable student borrowers that have difficulty both repaying their student debt and saving are people who borrow but never complete their degree.  The number of households in this situation could be drastically reduced by the implementation of policies that reduce or eliminate debt by first-year students.  The elimination of first-year student debt would also reduce average student debt burdens for all students with debt.  This proposal is far less expensive than the Sanders program to eliminate all college debt at public universities. 
  • Currently student borrowers must choose between a standard student loan contract and an Income Driven Loan (IDR) program as soon as they start loan repayment. In some instances, people who chose the IDR program paid more on their loan over the lifetime of the loan or failed to get the timely debt discharge as promised.  The standard loan contract does not offer the possibility of a loan discharge even if the borrower has low income in the future.   These problems can be mitigated by a modification of the standard student loan contract to include the elimination of all interest charges combined with accelerated repayment obligations 10 years after the initiation of repayment.

Modify rules governing tax incentives for employer-based health insurance and state exchange health insurance to allow for reduced loss of health insurance during economic downturns

  • The proposed solution to discontinuities in insurance coverage stemming from changes in employment involve – a rule change allowing employer subsidies of state-exchange insurance instead of employer-based insurance, the automatic conversion of employer-based insurance to state exchange insurance when employees are laid off, and a modification of the premium tax credit for state exchange insurance. More information on this proposal and other health care reforms can be found here.

New Political and Economic Dynamics:  The current political debate on Social Security involves proposals to either cut benefits or increase taxes and ignores problems caused by disparities in private retirement savings.

Any change to an inter-generational program must be phased in slowly to avoid political and economic turmoil.

However, most young adults would be unable to substantially increase their savings rate given current savings incentives or high debt burdens.

A higher eligibility age for Social Security benefits must be accompanied by reforms designed to reduce disparities in private savings.  These reforms will reduce the dependence of future generations on the Social Security program.

Many of the improvements in savings incentives, reductions in student debt and improvements to health insurance proposed here, are unaffordable if not accompanied by substantial new revenue or budget cuts.

Increases in retirement savings require changes in retirement plan rules and procedures.  Many current rules favor Wall Street over investors and tie investors into expensive products offering suboptimal returns or high levels of risk.

Social Security reform and private savings reform are intrinsically linked.

The proposals presented here would reduce wealth inequality and will improve the fiscal condition of the nation, truly a rare combination.

A 2024 Retirement Security Agenda

Pension and Social Security reform are inextricably linked because many retirees are highly dependent or Social Security, many workers nearing retirement are not in good financial shape and young adult are spending retirement funds early in their career. The recently enacted Secure Act 2.0 does very little to assist workers who are having the hardest time saving for retirement. Republicans and Democrats are far apart in their ideas on how to fix Social Security and neither party recognizes that meaningful enhancements in private retirement savings are essential to a successful Social Security reform. This post discusses ways to fix both the private retirement system and Social Security.


Many American workers are not preparing well enough for retirement.

Around half of older workers do not have any funds in a defined contribution plan (401(k) or IRA.)

The median amount of retirement assets for people with retirement plans is around $109,000.

Around 13.7 percent of the 65-and-over population lives in poverty.

More older workers are entering retirement with mortgage debt or consumer debt.

Many older workers cannot remain in the workforce because of poor health.

Economic downturns tend to result in a larger increase in unemployment for older workers than for younger or middle-aged workers.

Around 40 percent of older Americans are entirely dependent on Social Security.

Current law links future Social Security payments to the balance in the trust fund. Projected decreases in the trust fund would lead to a 20 percent in Social Security benefits in 2035, barring changes to the trust fund or current law.

Nearly 60 percent of young workers between the ages of 18 and 34 have already taken funds out of their retirement accounts to maintain current spending.   Early disbursements from retirement plans by young adults are especially high for people with high levels of student debt.

The traditional 60/40 portfolio held by many retirees loses substantial value in a period where the stock market falls, and interest rates rise. 

Congress and the Administration have not prioritized retirement income issues and are not close to addressing the looming Social Security problem.

Documenting the lack of progress:

Our leaders are not moving us forward on efforts to increase private savings for retirement or on efforts to fix the looming Social Security problem.  

Congress has passed some legislation, most recently, the Secure Act 2.0, impacting savings through 401(k) plans and IRAs.  Unfortunately, the recently enacted law does more to benefit investment firms and high net-worth savers than the workers who are struggling the most to save for retirement.  A more complete description of the Secure Act 2.0 can be found here and some of its shortcomings are listed below. 

  • Delays in implementation of Required Minimum Distribution do not assist retirees with low levels of retirement assets, people who tend to deplete their retirement accounts early in their retirement.  Provision increases fees received by investment firms.
  • Shorter waiting period for participation in 401(k) plans does not shorten vesting requirement and may benefit relatively few workers because many part-time workers do not stay at the same firm for a long time.
  • A provision clarifying that employers can contribute matching funds to 401(k) plans for student loan payments does not assist workers at firms without a 401(k) plan or firms with a 401(k) plan that do not match employee contributions.
  • The automatic 401(k) enrollment provision and automatic increases in contribution will reduce savings through other vehicles and will lead to relatively little additional savings if funds are distributed prior to retirement.

Around 40 percent of retired households are totally dependent on Social Security and many more are highly dependent on Social Security.    Expansion of private retirement spending is important by itself and has major implications for Social Security reform efforts.  

The implementation of some Social Security reform proposals that would lead to abrupt changes in benefits could not be applied to workers nearing retirement without causing large increases in poverty among the elderly.   

The Social Security trustees project that automatic benefit cuts to Social Security could occur in 2035 and that automatic Medicare benefit cuts could occur as early as 2028.

Democrats and Republicans are wide apart on what needs to be done to prevent automatic cuts to entitlement programs.  Democrats stress the need for additional revenue.  Republican proposals often call for large benefit cuts, many of which are applied to workers nearing retirement.

One proposal that could receive some bipartisan support inside a larger package involves increasing the cap on wages subject to Social Security taxes.  Current rules apply Social Security taxes to the first $160,200 of wages.  Go here for a discussion of proposals to eliminate or modify the cap on Social Security taxes.

Republicans tend to favor plans to reduce benefits, raise the retirement age, and create private accounts to replace all or part of the current Social Security system.  Some of the Republican proposals discussed herewould result in quick changes impacting potentially impacting workers close to retirement.   For example, a proposal to increase the retirement age for full Social Security benefits by 3 months per year until 2040, when the full retirement age reached 70 would result in substantial poverty among the elderly because private retirement savings could not be increased in this time frame.

Timely changes to Social Security are essential to prevent automatic benefit cuts that would lead to large increases in poverty because of the lack of private retirement savings.  

Reforming private retirement savings:

Reforms of private retirement savings that expand savings for low-income and middle-income households are a prerequisite for meaningful Social Security reforms because so many households are dependent on Social Security.   

There are six problems preventing workers from accumulating sufficient retirement savings prior to retirement.  Steps must be taken to address each problem. 

First, workers are free to disburse all entire savings from their 401(k) plans prior to retirement. Around 60 percent of young workers have tapped part of their retirement savings prior to age 34.  Steps must be taken to restrict pre-retirement disbursements from retirement plans and to incentivize workers from reducing retirement savings prior to retirement.

Proposed policy changes to address pre-retirement leakages from retirement accounts include:

  • Prohibit pre-retirement distributions from retirement plans for 25 percent of all contributions.   The prohibited distributions could be used to purchase an annuity that would not pay out until the retiree reaches a certain age.
  • Require automatic rollover into IRAs for all workers making a job transition with 401(k) balances less than $50,000.  (Current law allows but does not require automatic rollovers.)
  • Prohibit loans from 401(k) plans. Replace loans with limited tax-free and penalty-free distributions from the newly created emergency funds inside a 401(k) plan.

Second, workers reliant on Individual Retirement Accounts (IRAs) have less generous saving incentives than workers with access to employer-based 401(K) plans. Workers dependent on an IRA without access to a 401(k) have a lower contributions limit, do not have access to an employer match, and do not have access to retirement incentives for student loan payments.

Proposed changes to rules that reduce or eliminate discrepancies between savings through IRAs and savings through 401(k) plans include:

  • Create automatic contributions to IRAs for people without access to employer-sponsored 401(k) plans, patterned after the rules that are currently applied to automatic enrollment into 401(k) plans.
  • Change tax law to allow for employers to make matching contributions to worker contributions to IRAs like the ones currently allowed for 401(k) plans.
  • Equalize IRA and 401(k) contributions limit and deductibility limits on IRA and 401(k) contributions.  
  • Change tax law to allow tax-free contributions to IRAs by firms hiring contractors or gig workers instead of direct employees.

Third, the current tax preference for contributions to 401(k) plans and deductible IRAs favors higher income people with higher marginal tax rates.  Tax savings from expenditures from Roth IRAs in retirement also disproportionately benefit higher-income taxpayers.  Income related gap in subsidies could be altered by changes to the tax code.

  • Replace existing tax exemption for contributions to traditional 401(k) plans and the tax deduction for contributions to deductible IRAs with a tax credit.
  • Create a tax credit for first $2,000 contributed to a retirement plan and allow tax deduction for additional contributions up to a cap.

Fourth, many workers are now diverting retirement savings to health savings accounts and flexible savings accounts to pay for health expenses that are no longer covered by health insurance.  This is a growing problem due to the growing use of high-deductible health plans.

Proposed policy changes to offset the loss of retirement income due to the growth of cost-sharing between insurance companies and insured households include:

  • Allow for the use of health savings accounts for people with lower deductible health plans to reduce the need for large contributions to health savings accounts.
  • Change rules governing flexible savings account to allow people to place unused flexible savings account funds in a 401(k) plan or IRA rather than lose the unused funds.  It would be appropriate to tax funds transferred from a flexible savings account to a retirement account.

Fifth, fewer than 15 percent of retirees have an annuity inside their retirement plan.   The primary reason for the low level of annuity income is the cost of annuities.

  • Mandate that 25 percent of funds contributed to a retirement plan be used to purchase an annuity.

The source of funds for the mandatory annuity purchase could be the funds the person is not allowed to disburse prior to reaching retirement age.

The rule requiring all workers make an annuity purchase would lower annuity prices because voluntary annuity purchases are favored by healthy people with long life expectancy.   

Sixth, retirees often suffer when inflation erodes the value of bond and stocks. Many workers cannot afford to save much outside their retirement plan and current tax law does not allow individuals to purchase series I bonds inside a 401(k) plan or an IRA.  Many assets inside a 401(k) plan that proport to be inflation hedges lose value in an inflationary or high interest rate environment.

  • The most effective way to prevent reduction in retirement plan wealth in a period when inflation and interest rates rise, and stock prices fall is to allow and encourage the purchase of Series I savings bonds inside a 401(k) plan or IRA.  Series I savings bonds never fall in value and have substantial upside in an inflationary environment.   Go here for a discussion of advantages of Series I Savings Bonds.

The primary effect of the current restrictions on Series I Savings bonds is to increase the demand for financial assets and ETFs that are less effective in protecting investors from inflation than Series I Bonds.

Reforming Social Security:  

The expansion and improvement of private retirement savings options will reduce dependence on Social Security by future generations and allow for the consideration of a broader range of Social Security reform options including eventual reductions in benefits.

The Social Security reform measures considered here include:

  • A new tax earmarked for Social Security and Medicare.    The tax would be imposed on all forms of income and would have a progressive tax structure.
  • Increase in both the minimum retirement age for Social Security benefits and the age for full benefits, by one year each phased in over a 24-year period with a one month increase in the retirement age every two years.   The age at which people receive the maximum allowable Social Security benefit would remain unchanged.
  • Guarantee future Social Security benefits by allocating some general tax revenue towards future benefits if the Trust fund balance falls to a certain level.

Economic Notes on the Policy Package:

  • The combination of tax credits to stimulate private retirement savings, tax increases to fund current Social Security and Medicare benefits and long-term increases in the retirement age create a healthy macroeconomic environment and will lower household financial distress in retirement.
  • Short-term changes in tax revenue will be modest because losses in tax revenue from tax credits to stimulate private retirement savings are offset by increases in tax revenue from the new tax to maintain Social Security and Medicare benefits.
  • The phased in increases in the retirement age will not have an immediate impact on government deficits but will reduce future Debt-to-GDP ratios.   Since markets are forward looking the projected lower future debt burdens will have a beneficial impact on asset prices even if near term deficits rise. 
  • The tax base to continue funding Social Security and Medicare benefits should be relatively broad.  The tax could be imposed for all households making more than $50,000.  The tax would be progressive.  The marginal tax rate might range from 0.5 percent to a cap of 5.0 percent.  The tax would be applied to both wages and investment income.

Concluding Remarks:  Unless changes are made to rules governing Social Security and Medicare there will be automatic benefit cuts once trust funds assets are partially depleted. Many Republicans favor large and abrupt changes to Social Security benefits and the retirement age.  Any abrupt change in benefits would have an extremely adverse impact on household poverty and on aggregate demand.

A reduction in Social Security benefits that is not preceded by a substantial expansion in private retirement savings by the workers who are now having the most difficulty saving for retirement would lead to catastrophic financial impacts for many households.  This outcome can only be avoided by coupling private pension reforms with Social Security reforms.

David Bernstein is the author of A 2024 Health Care Reform Proposal.

Policy Question on Payroll Tax Holiday

This post will be updated sporadically with a policy question that troubles me. People who want to follow these thoughts need to either check this blog or my groups Policy & Politics and Finance Memos on Facebook.

The payroll tax holiday in the 2.0 trillion pandemic stimulus bill includes a requirement that businesses repay payroll tax relief in the future. A previous payroll tax holiday created in 2010 had the Treasury reimburse the Trust fund with general tax revenue.

Many defenders of Social Security thought the 2010 approach was bad policy because historically only payroll taxes and not general tax revenue was used to fund the trust fund. They though this approach might, by increasing deficits, reduce support for Social Security.

My view is that no one cares about the deficit anymore. Trump increased the deficit during a prosperous economy and the new stimulus bill is 50 percent of the budget without meaningful offsets.

My concern is that small companies will be unable to simultaneously pay back payroll taxes and new tax on ongoing payrolls. The double payments after the payroll tax ends will bankrupt some companies and slow the economy.

Should the Treasury reimburse the Trust funds for revenue lost from the payroll tax or should the government require companies make extra payments in the future to make up for this lost revenue?

My vote is that the Treasury should use general tax revenue to shore up the Social Security system both now in this emergency and in an ongoing basis. Hard for Republican budget hawks to argue for cuts to Social Security when every single one of them voted for Trump’s corporate tax cuts in relatively prosperous times.

Put your vote in the comment section of Policy & Politics.

Downsizing and the Social Security Claim Decision

I am making up and answering my own financial questions.  Please send your actual questions to me.

Question:  I am turning 62 in 2013 and it is definitely my time to retire.   I am single and would like to do something other than work.  I have modest means.  My main assets are my house, my 401(k) plan and a small amount of liquid assets.  The current value of my home is $450,000.   My 401(k) balance is $250,000.  I have a mutual fund with $30,000.  I have no loans on my car, which is eight years old and has 100,000 miles.

I will be entitled to a Social Security benefit of $1,000 as soon as I reach age 62.  I need to leave my job and have some fun but I am worried that I will outlive my savings.  What is your advice?

Caveat:   Your situation may be similar to my fictional questioner but there are always more details to be considered.   Please consider but do not over rely on this advice.

Analysis:  Many people are in this situation.  Their total assets are relatively modest and most of their assets are tied up in their home.  Some liquid assets are needed for emergencies.  A new car purchase may not be far off

Since you were born in 1951, your full retirement age is 66 years.  The decision to claim Social Security early will result in a reduction in your Social Security benefits of around 25% relative to the benefit that could be obtained by delaying a claim until age 66.

Your financial security would be greatly enhanced if you could delay claiming Social Security benefits.  In order to delay claiming Social Security you need to either take disbursements from your 401(k) plan or somehow tap your housing equity.


Your 401(k) plan is modest and taking immediate disbursements is not a wise financial strategy.  First, the 401(k) balance might grow more if disbursements are delayed.  Growth in 401(K) assets is of course determined by market outcomes.  Second, a delay in 401(k) disbursements will allow you to either receive 401(k) benefits later in life or take a larger disbursement each year.

While your marginal tax rate is low it is important to remember that 401(K) disbursements are taxed as ordinary income.

Let’s consider the possibility of tapping home equity to fund your retirement.  In particular, let’s consider five options – (1) selling your home and renting, (2) selling your home and buying a smaller home, (3) renting your home to a tenant and renting a smaller place for yourself, (4) finding a roommate, and (5) taking out a reverse mortgage.

Selling your home and renting:    The viability of this option depends on the rent you must pay in your new place.  Moreover, you become susceptible to rent increases, which could be significant over time.   Work by Jonathan Skinner cited in a previous post indicates that renters must save more to have an adequate retirement income than do homeowners.

The capital gain up to $250,000 on owner-occupied homes is not taxed.

Selling your home and buying a replacement home:  The viability of this option depends on the cost of the replacement home.  The replacement home could be in a place with a lower cost of living.  There are lots of articles on the web listing affordable retirement locations.

One risk of relocating is that you may be unhappy in your new location, especially if you move away from family and friends.  You may want to keep your home and rent until you are sure you are happy at your new location.  However, you may have to pay capital gain tax on your old home if you delay its sale and it becomes an investor-owned property.

Renting your home to a tenant and renting your own place to live:   The viability of this option depends on the amount of rental income you will get. This option would allow you to move to a new location and determine if you like it.  There is a risk that your home will be vacant some months.   There is also a risk that your tenant will trash your home.  (I heard of one family who rented their home and had their home destroyed by their tenant’s six dogs.  The insurance company refused to pay.)  You will need to hire a reliable property manager.  You will be subject to unexpected expenses.  Rental income is of course taxed but your marginal tax rate is low.

Under this option, you may have to pay capital gains taxes on the gain on your home.

A roommate:  The viability of this option depends on the amount of rental income obtained from the roommate.  You need a compatible or at least non- disruptive tenant.

Reverse mortgages:  Many financial advisors advocate that individuals in your situation stay in their home and take out a reverse mortgage.  Reverse mortgages entail risk.  A recent New York Times article documents problems with reverse mortgages uncovered by federal and state regulators.

Increasingly, the reverse mortgage market is dominated by smaller mortgage brokers and firms that were formerly subprime lenders.  Fees tend to be high and are often unrevealed.  There have been several cases where a spouse that was not on the reverse mortgage loans was required to repay the entire loan in order to remain in her home.  The rate of default on reverse mortgages is at a record high, 9.4%.  Moreover, an increasing number of people obtaining a reverse mortgage are doing so at a younger age; thereby, adding to their financial risk.

Concluding thoughts:  In my view, you need to delay claiming your Social Security benefit and delay disbursing funds from your 401(k) plans.   This could be accomplished by tapping your home equity.  There are a variety of ways to tap your home equity.

Avoid taking out a reverse mortgage.

Also, your retirement could be made much more secure if you found a part-time job.