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How To Value Social Security

Last update on: Mar 16 2020
how-to-value-social-security

Your portfolio is more conservative than you think.

Most people don’t consider Social Security and other pensions and annuities when considering their investment portfolios. Even most financial planners and other investment professionals do not include Social Security and other pensions when allocating a portfolio.

A pension such as Social Security has many of the characteristics of a high quality bond. You receive regular payments from it, and the payments usually have a high level of security. Major differences are that a pension cannot be sold on the market, and payments include both principal and income.

You should try to put a value on Social Security benefits and counts this as bonds when determining how to invest your portfolio. Since Social Security and other pensions have characteristics of bonds, ignoring the pensions means your investment portfolio probably is overweighted to bonds and is more conservative than you need it to be. In addition, many people save too much or worry too much because Social Security wasn’t valued and considered.

Younger people believe that they cannot count on Social Security and prefer to ignore it in their planning. That might be a reasonable approach, but anyone age 50 or older should try to value Social Security and consider it when making investment allocation decisions.

Valuing a fixed-payment pension (such as most corporate pensions or insurance annuities) is fairly simple. You need an estimated life expectancy and a discount rate (interest rate). For life expectancy, you can start with the IRS tables for required minimum distributions and cut it in half, or you can consult an insurance book at the library. Ideally the interest rate is the current yield on a treasury bond with the same maturity as the life expectancy. After obtaining these numbers, simply look up the “annuity factor” in a table such as the one nearby.

For example, suppose a 70 year old is receiving a Social Security benefit of about $900 monthly. His life expectancy according to the IRS is 27.4 years, so he uses 13 or 14 years. Let’s say the current treasury yield on a comparable debt is about 5%. Consulting the annuity factor table, technically you should interpolate the difference between 9.394 and 10.38, or you can use 10.38 to make things easy. Multiply 10.38 by the annual income of $10,800. The result is a current value of $112,104 for the benefits.

What if you aren’t receiving the benefits yet?

Then another step with some higher math is involved. First, determine the value of the benefits at the age you’ll begin receiving them, using your life expectancy at that age. Second, divide that benefit value by one plus the interest rate raised to the number of years between now and when the benefits will begin.

Suppose your benefits will be valued at $135,000 at age 65, but you are age 60, and the appropriate interest rate is 5%. Then the present value of your benefits is $135,000/(1.05) raised to the fifth power. To raise 1.05 to the fifth power, simply multiply it by itself five times. The resulting value for the benefits is $105,776.03.

That is the simple approach to valuing Social Security benefits. The benefits actually are worth more than that for a couple of reasons.

Social Security benefits are not fixed payment benefits. The level of benefits rises each year with inflation. That makes them more valuable than a fixed payment annuity. In addition, if you are married payments will continue to your surviving spouse, provided your spouse survives and has lower lifetime earnings than yours. Again that makes the benefits more valuable than in the simple calculation. This second factor is easy to adjust for by using a joint life expectancy instead of a single life expectancy.

The inflation-indexing of benefits can be adjusted a couple of ways. One way is to use a financial calculator that is programmed to determine the present value of an annuity with rising payments. Select an inflation rate of 2% to 3% to get the value.

Another option is to use the first method presented, but instead of the regular treasury bond yield use the yield on the appropriate TIPS (Treasury Inflation Protected Securities) bonds. This yield factors in the market place’s expectations for inflation and will be less than the regular treasury yield. The result will be a higher value on the benefits.

These are fairly simple methods for calculating the value of Social Security benefits and other pensions. More sophisticated and accurate methods are available for those who want to delve into higher math, and those methods are appropriate for married couples in particular. The methods given here, however, are significantly better than not assigning any value to the benefits and will get you off to a good start.

After Social Security benefits and other pensions are valued and included in the portfolio, reconsider your investments. When the benefit values are coupled with existing bonds, an investment portfolio might be more heavily weighted to bonds than previously thought. This is particularly true for those who retire with significant defined benefit pensions, such as government and military retirees. An investor might realize that he or she is able to take more risk in the portfolio because of the existence of Social Security and other benefits.

The pensions should be re-valued periodically to reflect new life expectancies and interest rates. Otherwise, the investment portfolio will be out of balance over time.

One additional factor to consider is the financial stability of the pension payer. For Social Security and government pensions, this usually isn’t a factor. You can assume the payments will be made. For some private sector pensions, such as airlines, you might want to reduce the value to reflect some uncertainty that the full pension will be paid. How much to reduce the value is at your discretion.

Your Social Security benefits and any other pensions are valuable assets. They also are very conservative assets. They should be considered when computing both expected retirement income and your portfolio allocation.

Valuing Social Security

Interest Rate
Years 2% 3% 4% 5% 6% 7%
5 4.713 4.580 4.452 4.330 4.212 4.100
7 6.472 6.230 6.002 5.786 5.582 5.389
9 8.162 7.786 7.435 7.108 6.802 6.515
11 9.787 9.253 8.760 8.306 7.887 7.499
13 11.348 10.635 9.986 9.394 8.853 8.358
15 12.849 11.938 11.118 10.380 9.712 9.108
17 14.293 13.166 12.166 11.274 10.477 9.763
19 15.678 14.324 13.134 12.085 11.158 10.336
21 17.011 15.415 14.029 12.821 11.764 10.836
23 18.292 16.444 14.857 13.489 12.303 11.272
25 19.523 17.413 15.622 14.094 12.783 11.654
27 20.707 18.327 16.330 14.643 13.211 11.987
29 21.844 19.189 16.984 15.141 13.591 12.278

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