Electing Social Security early: a variable annuity with guaranteed withdrawal benefits can make up for taking lower Social Security benefits at age 62.

With the first of the nation's 76 million baby boomers turning 60 this year, many will ultimately decide to elect early Social Security benefits. In fact, Social Security Administration statistics indicate that 72% of Social Security benefits commence at the early retirement age of 62.

However, the choice to elect early Social Security benefit payments at this age results in a reduction of the Social Security benefit otherwise payable at the full retirement age. Since mortality projections suggest that more than 28% of payees choosing early Social Security benefits would be better off waiting until the full retirement age, why are so many making an unwise economic choice? Some individuals might have a pressing economic need that discourages delaying receipt of Social Security benefit payments. Others might have an aversion to deferring receipt of a benefit that has already been paid for, or may fear losing a "paid-for" benefit in the event they die before full retirement age. And yet another reason might be concern with the viability of the Social Security system itself.

The primary implication of choosing an early Social Security benefit is the individual will receive a reduced benefit for as long as he or she lives. This may cause economic pain for a couple that chooses early benefits, particularly if the couple lives past their crossover ages where deferral would have provided a greater combined benefit. Upon the death of a spouse, this problem becomes more pronounced. At that time, the surviving spouse is entitled to the greater of his or her own benefit or his or her deceased spouse's benefit. Regardless of which benefit is chosen, the surviving spouse will be dependent on that single benefit payment, already reduced for the early retirement benefit election, for the rest of his or her life.

While the best choice may often be to choose not to elect a reduced Social Security benefit in the first place, if a couple does so, then the analysis no longer has to do with whether delaying is better. Rather, it shifts to how the surviving spouse may maintain the same income generation and quality of life when his or her spouse dies.

One possible solution is to purchase an annuity with a lifetime-withdrawal benefit guarantee at the time Social Security benefits are elected. By doing this, the couple can use the annuity income stream that is guaranteed for life to replace the lost Social Security benefit upon the death of a spouse.

For example, assume a husband and wife are both born in 1944 and choose to start Social Security benefits in 2006. If each is entitled to the average benefit, their total annual Social Security benefit will be $20,856 ($12,648 for the husband and $8,208 for the wife).

Should the husband die, the wife will be able to step up to the husband's $12,648 annual Social Security benefit, but will no longer be entitled to her annual benefit of $8,208. Therefore, she will experience an annual household income loss of $8,208.

Now let's assume that the couple purchased a $100,000 annuity contract with a lifetime guaranteed withdrawal benefit, an optional rider available for a charge in addition to the basic annuity cost, that provides a guaranteed 5% annual growth of the withdrawal value for 10 years. After 10 years the contract would have a minimum protected withdrawal value of $162,889. The minimum guaranteed annual payment, in turn, would be $8,144 per year, or almost enough to entirely replace the lost income stream due to the husband's death at age 72. If the contract investment return is greater than the guaranteed 5%, the use of the guaranteed lifetime withdrawal benefit could result in an increase in annual income at the husband's death.

In the event the husband does not die at 72, the financial outcome is even better for the couple. They may either continue to accumulate contract value within the annuity contract, or turn on the guaranteed lifetime withdrawal benefit to increase their annual income.

Financial professionals are not always faced with optimal facts, and are challenged with how to best position a client in light of decisions that run counter to their counsel. In the case of Social Security benefits, the behavioral reality is that most clients will choose early commencement of benefits, although many would be better off waiting. The use of an annuity with a guaranteed lifetime withdrawal benefit can mitigate the adverse consequences of such action and enhance the income available for the surviving spouse.

Contributor Robert A. Fishbein is vice president and corporate counsel, tax department, for Prudential Financial. He may be reached at [e-mail].