For an investment return that tops those offered by hedge funds, insurance firms or Wall Street banks, baby boomers should look to Social Security.
That's right: The same math that is driving Social Security costs higher can provide fat returns for people approaching retirement. All you need is a way to make ends meet while delaying the start of Social Security benefits from age 62 to as late as 70.
Sure, those who defer will miss a bunch of checks in the early years—but then will lock in bigger payments for life. This trade-off can be calculated as an investment return, just like a bond yield.
I asked John Shoven, director of the Stanford Institute for Economic Policy Research and author of numerous books and studies on Social Security, to perform such an analysis. The numbers might come as a surprise.
Consider an unmarried man in average health, age 62—the youngest age for starting retirement benefits. His payoff for waiting until age 67 to collect is the equivalent of buying a long-term bond that pays 3.2% a year. For a woman, all else held equal, it's a 4% yearly return, according to Mr. Shoven and his research partner, Sita Slavov at Occidental College.
Here's the whopper: For married couples, if the higher-earning spouse delays payments from age 62 to 70, but at age 66 begins collecting spousal benefits from the lower-earner's plan (as Social Security allows), the return is like owning a 7% bond.
Not just any bond, either. The fictional alternative would have to be government-guaranteed and provide periodic inflation adjustments. And the income would have to be tax-free for most recipients.
The closest real-world investments are Treasury inflation-protected securities, or TIPS. They're government-backed and inflation-adjusted, but they're subject to federal (but not state and local) tax. Ten-year TIPS on Thursday paid 0.21%. That's not a misprint; bond rates are so low that investors are paying to own TIPS just to get the inflation adjustment.
Put differently, a 7% annual return for delaying Social Security payments is for many investors better than a bank certificate of deposit that pays more than 10%, considering the inflation adjustment and tax advantages.
Social Security wasn't designed to offer such generous terms to those who wait. Amendments in 1956 and 1961 gave participants a choice to collect benefits as early as 62 rather than wait until full retirement age, then 65. The formula determining payment size made collecting early as good a deal as waiting, says Gary Burtless, an economist and Social Security specialist with the Brookings Institution, a think tank.
Two things changed. Life expectancies have soared since the 1960s, while interest rates have collapsed. Insurance companies, which sell annuities that can turn savings into lifetime payments, monitor both factors to keep their terms competitive and profitable, says Robert Fishbein, vice president and corporate counsel at Prudential Financial PRU -2.03%.
But for Social Security to adjust, Congress must act. The plan's current math uses a return assumption that dates to 1983. It assumes investors can easily find risk-free investments that pay 2.9%—after inflation. As the aforementioned TIPS yields suggest, the actual rate now is below zero.
"We look at long-term averages, not short-term swings in interest rates," says Stephen Goss, chief actuary at the Social Security Administration. The reward for delaying benefits might look generous next to today's low rates, he says, but rates should eventually normalize to higher levels.
Some retirees find advice on when to start Social Security benefits confusing. That's because even a ballpark calculation must consider not only factors like gender, marital status, income and health, but also long-term changes to life expectancies and short-term changes to interest rates.
For now, the deal remains sweet. The plan's trustees say there is enough cash to pay full benefits through 2036 and three-quarters of benefits thereafter, and Mr. Goss says such deadlines historically have served as a call to action for Congress.
Members of both parties are considering legislation to rein in costs. "We clearly have to make changes to things like the retirement age to keep the program affordable," says Sen. Tom Coburn (R., Okla.), the ranking member of the Finance Subcommittee on Social Security, Pensions and Family Policy.
Future changes aside, with interest rates this low, delaying benefits is a good idea for just about anyone of average health. There are only a few exceptions, according to Mr. Shoven and Ms. Slavov. A single 62-year-old man of average health should delay until 69, not 70. Given his life expectancy, 69 is the age that maximizes his "net present value" of estimated payments, as a Wall Street analyst might say.
The lower earner in a two-earner household doesn't get much benefit delaying past 66. Social Security also provides benefits to spouses, and in some cases participants can collect both regular and spousal benefits. Most eligible couples should start collecting spousal benefits at 66, according to Mr. Shoven and Ms. Slavov.
Most retirees miss out on the juicy returns for delaying benefits. The most popular age to begin collecting is 62. Many retirees simply need the money. But low-income workers approaching retirement should try especially hard to wait, even if it means working longer, says Prudential's Mr. Fishbein, because this might be the best investment deal they'll see.
The wild card is health. Retirees with life-shortening illnesses might be better off collecting early. Determining how each illness affects the equation is beyond the scope of this column, but Mr. Shoven offers a rule of thumb: "If you're healthy enough to work at 62, you should probably wait as long as you can to collect."
—Jack Hough is a columnist at SmartMoney.com. Email: jack.hough [at] dowjones.com