Valuing Social Security as an Asset in Your Retirement Plan

All too often, I speak with current or future retirees who think along these lines:

• “We don’t want to assume Social Security will be there for us. Let’s just focus on the assets in our control.”
• “I know Social Security is there, but it’s so small. Let’s play it safe and ignore it for now.”
• “Social Security is only $2000 monthly, whereas my IRA has $900K. Social Security is a drop in the bucket.”

These ideas are not only wrong but perilously so. To overlook Social Security is an unreasonably conservative retirement assumption.

In fact, when I reframe Social Security in a different light, people change their minds (almost) every time. They realize, “Oh man – Social Security is huge. I never knew…” It’s a gift that keeps on giving.

I’m going to walk you through that reframing today. In your retirement plan, we must value Social Security as an asset (and a valuable one at that!).

Will Social Security Be There?!

Will Social Security still be there in 5, 10, 20+ years?

Yes. I have no doubts, and I’ll explain why. But will it look exactly the same as it looks now? Quite possibly not.

To understand why, we need a quick primer on Social Security:

• Most of the government’s annual Social Security outflows (~95% in 2022) are covered by current-year Social Security tax inflows.
• That difference (~5% in 2022) is withdrawn from the Old Age and Survivor’s Insurance (OASI) trust fund. It’s a band-aid to bridge the gap.
• That “band-aid” is growing each year and will continue to do so under current legislation.
• With ever-growing band-aids, the trust fund is on a trajectory to be fully depleted by 2034.

Most people hear those facts and think, “This is an unmitigated disaster…no more Social Security by 2034!?”

However!!!

They forget about the first bullet above. Most Social Security outflows are covered by annual taxes. As of 2034, roughly ~80% of the projected annual Social Security outflows will be covered by tax inflows. Social Security would not disappear completely; instead, the shortfall would only deliver 80% of what was promised.

Of course, paying less than full benefits is not an acceptable way to run this vital program, and Congress will need to act to fix it. My simple brain sees two solutions: increase inflows (more tax) or decrease outflows (higher Social Security age). But they haven’t asked me yet…

My point remains: Social Security will still be there.

The “Lump Sum” of Social Security

Now – let’s find a way to value Social Security as an asset in our financial plans.

The average Social Security benefit for a retired couple is $3800 per month. However, most assets on our balance sheets are lump sums, not income streams. How do we view our Social Security income streams as “lump sums” to make them comparable to an IRA or a bank account?

The 4% rule is a good start.

The 4% rule helps us equate a $1,000,000 portfolio to a $40,000 annual income stream. Let’s just use that math in reverse. Of course, there are caveats involved. Namely, the 4% rule is built for 30-year timelines and is conservative.

Does the average person live 30 years after starting to collect Social Security? No!

The average 65-year-old American male has another ~19 years of life left, and the average 65-year-old American female has another 22 years left. For more info, here’s a quick primer on life expectancy data. We’ll round those numbers to 20 years.

How Long Will You Live?

For that 20-year timeline, instead of the 4% rule, we’re better off using a 6% rule (which, if you’re curious, seems reasonable based on my playing around with Engaging Data’s X% Rule calculator).

When we do that math, our $3800 per month Social Security income stream (or $45,600 per year) is equivalent to a $760,000 portfolio that we’re drawing down at 6% per year.

That’s right. The average newly retired American couple’s Social Security payments are equivalent to having an additional $760,000 in their nest egg.

The Treasury Bond Method

But since Social Security is a guaranteed payment, perhaps a better proxy than the 4% Rule (or 6% Rule) is to use a U.S. Treasury bond, backed by the full faith and credit of the U.S. government? In other words, how do I recreate an average couple’s ~20-year Social Security income stream using 20-year bonds?

As of my writing this, the 20-year US Treasury rate is about 4.62%.

The question to ask is…

• If I had guaranteed 4.62% for the next 20 years…
• And I needed to pay myself $45,600 inflation-adjusted (like Social Security does) for the next 20 years…
• How much in bonds would I need to buy today?

The answer is ~$755,000. Here’s the Google sheet showing this math.

For what it’s worth, the fact that $755,000 is so close to our 6% rule answer of $760,000 is pure coincidence. While it’s nice the numbers are close together, I don’t think we should view that fact as evidence that the number must therefore be accurate.

For example, if today’s 20-year bond rate was 4.00%, the lump sum number would be $801,000

If the 20-year rate was 5.00%, the lump sum number would be $728,000

Does Delaying Matter?

What if a person decides to delay Social Security to a later age, thus increasing their monthly benefit? Or if they’re forced to draw Social Security earlier than desired, decreasing their monthly benefit? How does this affect the lump sum value?

In short, there’s minimal effect. The actuaries have you beat (mostly), though the actuarial data is a bit outdated.

As Wikipedia says, an actuary “is a professional with advanced mathematical skills who deals with the measurement and management of risk and uncertainty. The name of the corresponding field is actuarial science which covers rigorous mathematical calculations in areas of life expectancy and life insurance.”

The actuaries at the Social Security Administration have the job of making Social Security fair and un-rig-able. Your Social Security benefits will increase if you wait until age 67 or age 70 precisely because those actuaries know that, on average, you’ll have fewer years to collect them.

Higher rate x fewer years = lower rate x more years.

Now, the Social Security actuaries last updated this math in 1983. Life expectancies have increased since then. And because we’re living longer, the average person would benefit from delaying their Social Security until age 70. It’s not a huge difference, but it’s there. Until the actuaries update their math, this fact will remain true.

Of course, the joke in financial planning is, “Tell me when you’ll die, and I’ll tell you when to start collecting Social Security.” We just don’t know.

But the rough outline is:

• If you die before age 77, then collecting as early as possible would have been best.
• If you die between ages 78-80, then all scenarios are roughly equal (all within ~6% of one another)
• If you die after age 80, then waiting until at least “full retirement age” of 67 has distinct advantages
• If you die after age 84, then waiting until the maximum collection age of 70 becomes optimal, and it only gets better the longer you live. For example, if you die at age 90, then collecting at age 70 would have been ~28% better than collecting at age 62.

Here’s my Google sheet if you want to play around with it yourself.

Quick aside: there is another set of “hacks” worth knowing on this front.

If you have reason to believe you’re likely to live shorter than average (family history, preexisting conditions, etc.), you should consider collecting your Social Security income as early as possibly.

And vice versa. If you’re likely to live a long life, you should consider waiting on Social Security income until full age 70.

If a couple wants to hedge their bets, the lower earning partner should collect Social Security has early as possible, and the higher earning partner should wait as long as possible. This is because the lower earning partner will inherit the larger benefits should the higher earning partner die first.

Social Security As Part of a Portfolio

How does Social Security income fit into overall portfolio construction?

I like to think of portfolios from a bottoms-up, goals-based allocation perspective. From that point of view, Social Security income reduces the short-term income needs from our portfolio, thus pushing more of our portfolio into long-term investments (a.k.a. stocks, illiquid investments).

If a couple needs $10,000 per month to fund their retirement, their portfolio will be drastically different depending on whether they account for ~$3800 of that income coming from Social Security.

This Google Sheet shows what I mean. I looked at a $1.8M portfolio. The couple who wisely includes Social Security income in their math can reasonably build a 60/40 portfolio for their retirement. On the other hand, the couple who neglect Social Security income would end up building a 40/60 portfolio. That’s a big difference!

Again, Social Security for a newly retired couple can be considered a $700K—$800K allocation to fixed income. When you include that into the 60/40 portfolio described above, it looks similar to a 40/60 allocation.

Granted, we need to remember a couple important caveats:

• While considering Social Security as a lump sum is helpful from a portfolio construction standpoint, we still cannot withdraw Social Security as a true lump sum (like we could an IRA or taxable account).
• The “value” of Social Security steadily decreases with age as our expected remaining lifespan decreases.

Conclusion

Going back to those opening statements:

• “We don’t want to assume Social Security will be there for us. Let’s just focus on the assets in our control.”
• “I know Social Security is there, but it’s so small. Let’s play it safe and ignore it for now.”
• “Social Security is only $2000 monthly, whereas my IRA has $900K. Social Security is a drop in the bucket.”

For the average new retiree, this is a $350K—$400K oversight per person, and twice that for a couple.

These aren’t drops in the bucket.

Thank you for reading! If you enjoyed this article, join 8000+ subscribers who read my 2-minute weekly email, where I send you links to the smartest financial content I find online every week.

-Jesse

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