Retirement Planning: Valuing Social Security Benefits

AUTHOR NOTE: This article is especially beneficial when read in conjunction with a recent article I wrote for Seeking Alpha; 10 Top ETFs To Secure Your Retirement Portfolio.


Retirement is intended to be a special time. Freed from the everyday constraints of a full-time job, it is an opportunity for you to enjoy life. For some, this may involve taking time to travel. For others, the opportunity to explore a hobby.

At the same time, you face challenges. If you saved and invested diligently over the course of your working career, you may have built up a nice nest egg. On the one hand, you do not want the value of that nest egg to be devastated in a market downturn. On the other hand, you (happily) may have a lengthy remaining life expectancy to plan for, and assets such as stocks may be required to help you keep up with inflation.

Enter Social Security

When deciding on an asset allocation you are comfortable with, you need to first consider your spending. How much income will you need to cover necessary expenses, such as housing and medical care? What about having a little extra for some of the joys of life referenced earlier?

At least for the foreseeable future, one component of that income will come from your Social Security benefits. But how might you evaluate Social Security in the light of your investment portfolio? Here’s how an article from Zacks proposes you look at it.

If you look at Social Security as an income stream, you can value it relative to other investments. For instance, if you receive $20,000 per year in Social Security, it’s similar to having a lifetime inflation-indexed annuity that pays $20,000 per year.

Looking at things from that perspective, if your assets can be expected to generate a return of 4% per year, that stream of income might be viewed similarly to having $500,000 in assets ($500,000 x 4% return = $20,000 annual income). Let’s further suppose that you have accumulated $500,000 in your retirement accounts. That view would imply that you effectively have a total of $1,000,000 in assets to allocate. It further argues that, when developing that allocation, you might view Social Security as part of your bond holdings. After all, bonds tend to offer stability and a consistent income stream. Given that, you may feel comfortable allocating a greater portion of your $1,000,000 retirement account to stocks, thereby attempting to preserve your purchasing power.

The Controversy

Here’s the caveat. This is controversial. Please go back and re-read that last point. I used bold text for a reason. Many financial planners argue against this view. They point out, correctly, that Social Security is not an asset. In other words, I proposed a “value” of $500,000 for assets that can consistently generate $20,000 in annual income. But the fact is, you don’t have $500,000 in actual assets. What if the Social Security structure is changed, and the annual benefits are decreased? How might that affect your plan? Are you interested in passing anything on to your heirs? Social Security won’t help. It ceases when you die.

Finally, before we move on, let me be clear that I am not advocating taking an extremely aggressive view of your retirement assets as a result. I am not suggesting that you allocate 100% to stocks in your retirement account, and then view matters as if you have a 50/50 allocation to bonds and stocks. On the other hand, what if you maintain, say, a 60-75% allocation to cash and short-term bonds in that retirement account? Might that be too conservative, causing you to lose purchasing power over time?

I think you get the point. There is certainly much to consider when making these decisions. If nothing else, I hope this article gives you something to reflect on when it comes to your personal situation. After all, that is different for each of us, and only you can decide what makes sense in your case.

The Present Value Of Your Social Security

How, though, can you go about getting a rough idea of the value of the income-producing power of your Social Security?

Financial analysis relies heavily on a simple calculation known as Present Value. Simply put, $110 received a year from now is worth less than $110 received today. How much less? What might be called the risk-free return you could receive on that $110.

I chose the value $110 for a reason, to offer a simple and intuitive example.

  • Example: Let’s say you could obtain a risk-free return of 10%. In this scenario, that $110 a year from now is worth exactly $100 today. Think about it. If you have $100 today and can obtain a guaranteed return of 10%, that $100 will be worth $110 in one year’s time. Now just reverse it. It all makes sense, doesn’t it? That process is known as discounting. You take some future value, and discount it back to the present, to today.

Ah, but when it comes to your Social Security benefit, how do we do this? After all, we are talking about a stream of payments you may receive for 10, 20, maybe even 30+ years (if you are truly blessed). On top of that, Social Security generally offers a small cost of living adjustment (COLA) increase each year. Finally, how do we properly discount this, in other words bring it all back to the present?

A Handy Excel-Based Tool

Fortunately, Excel is a very useful tool with which to perform this sort of calculation. I have built a little worksheet that may be helpful to you.

  • Caveat: This tool is relatively simple. You can find more precise financial calculators. And a good financial planner will be able to do a much deeper dive. However, this simple spreadsheet can at least give you a “quick and dirty” number that is reasonably close to accurate.

Take a quick look at the screenshot below, and then I’ll break it down for you.

Social Security Valuation Template

First of all, please note that data should only be entered in the 4 cells highlighted in yellow. Here’s a quick primer on each.

  • Cell B1 – Multiply your expected starting monthly Social Security benefit by 12. This becomes your Beginning Annual Benefit.
  • Cell B2 – Enter what you believe the average annual increase (COLA) will be over the term you expect to receive benefits. Enter “2%,” as an example, exactly as it is displayed (two point zero zero). I’ve got the cell formatted so that will translate into percentage.
  • Cell B3 – Enter the percentage at which you wish to discount those benefits. In the spreadsheet, you will see that I provide a link to the Federal Reserve website so you can see the latest rates for federal bonds of various terms. I suggest using the rate for 10-Year bonds, as that gives you some idea of the sort of risk-free (or guaranteed) return you could receive for a dollar you hold today over a 10-year span of time.
  • Cell B4 – Enter your life expectancy in years. So, if you are 62 and reasonably expect to live to 92, enter “30.”

The ‘Data Table’ (in the light green color) is where the calculations are done. You will notice that the Beginning Benefit and Discount Rate carry over directly from the data entry area. If you look closely at the annual ‘base’ amounts, you will notice that, starting in Year 2, each year is exactly 2% higher that the year before. That comes from the value you entered in Cell B2. The number in the right-hand column is the present value of the amounts for each year. A formula at the bottom of the column simply sums these and returns the answer to Cell B9.

  • NOTE: If you want to see the magic of “present value,” as an exercise enter the same value (e.g. 3.19%) in both Cells B2 and B3. You will discover that the present value for each year becomes exactly the same. Why? Because each projected annual increase is being discounted back to the present at exactly the same rate, so the effects of “inflation” and “discounting” precisely cancel each other out. As you think about this, your intuition will tell you something very important. In my example, with only 2% projected increases in Social Security each year, what’s happening to the present value in years 2-10? It’s decreasing, correct? That’s what inflation can do to your purchasing power. And that’s why you may want to think seriously about maintaining at least a reasonable allocation in stocks.

Finally, note that, in the example above, no values populate starting with Year 11. That’s because I provided a conditional formula for each year that says, expressed in English; “If the year for this row is greater than the life expectancy, turn all the formulas off and return “zero” for that year.” So, even though I provided 40 years worth of formulas, only 10 become part of the calculation in this example.

Accessing The Excel Spreadsheet

This file is stored on my Microsoft OneDrive account, so I can provide the ability to access the spreadsheet. I am going to do so at two levels.

First, here is a view-only link. This link will allow you to open and view the spreadsheet, however you will not be able to edit any of the values. If you would like a link which allows you to edit the file, I will offer you two options:

The first is to follow me on Twitter, and then send a tweet to @ETFMonkey. As long as you are following me, I will be able to send the link to you via direct message. I use Twitter more than perhaps anything else to share quick updates with my readers; everything from high-quality Seeking Alpha articles to quick action alerts with respect to my own portfolio as well as various investing and market commentary.

The second is to look for this section in the footer of my blog.

Follow ETF Monkey

Simply provide your email address and click ‘HOOK ME UP’ to sign up as a follower of my blog. In this case, I will use your email address to send the link.

As always, until next time, I wish you . . .

Happy investing!


Additional Reading

For readers interested in delving deeper into the question of whether, and how to, include Social Security when making investment decisions in retirement, here are 7 links for further reading. Some are pro, others are con. And that’s the way it should be.

Morningstar: 6 Retirement Asset-Allocation Pitfalls To Avoid

Seeking Alpha: When To Claim Social Security – A Debate

Seeking Alpha: John Bogle Thinks Social Security Should Be Treated As A Bond-Like Captal Asset: Should You And I?

Paul Merriman: Social Security Is Not An Asset

A Wealth Of Common Sense: Should Social Security Be Considered A Bond?

Zacks: How To Use Social Security In The Allocation Of Investments

Michael Kitces: Valuing Social Security Benefits As An Asset

DISCLOSURE: I am not a registered investment advisor or broker/dealer. Readers are advised that the material contained herein should be used solely for informational purposes, and to consult with their personal tax or financial advisors as to its applicability to their circumstances. Investing involves risk, including the loss of principal.

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