Net worth: How to value Soc Sec and state retirement payments

I don't know what the standard is, but personally I don't count either one.

Personal net worth is a balance statement, not an income statement. All income, including Social Security and state retirement payments, have nothing to do with your personal net worth.

Social Security is income, not net assets. If your goal is to size up your net worth to plan for retirement needs, you might remove SS from the need side, i.e. $20K from SS is $20K you don't need as an income stream from your assets.

Even if I were retired and getting SS, I don't think I'd ever consider it as a 'lump sum' net asset. It's not an asset I can will to my offspring or charity.

JOE

A rule of thumb is to take 25 times your expected benefit (or 20 times). Being the amount of money you would need to buy an inflation indexed annuity providing that benefit (although the benefits your spouse may receive post your death complicates the picture even more).

You would then need to discount back to the present day.

I would suggest you use a long term US treasury bond rate to do so as this cash flow is essentially risk free.

So say you are due to retire in 20 years time, with a projected benefit of $12,000 a year.

You could calculate the present value in two ways:

1. make the assumption that the benefit will rise by 4.5% pa (ie the discount rate). Your benefit is thus 25X12k = 0k as a current balance sheet amount

1. you make an assumption regarding the growth in benefits between now and then, say 2.5% pa

(1 + 0.025) to the power 20 = future benefit = > 19,663 pa. Multiply by 25

divide that FB by (1.0 +045) to the power 20 (ie the risk free bond rate compounded for 20 years) to get current benefit. = $203,000

To make it more exact, you could get a quote for an annuity rate available to you now, if you were retiring now. I am using 4% (about the right rate for the UK for a 65 year old man, in good health, inflation protected up to 2.5%, 50% spousal benefit). I am also assuming that that won't change between now and then (it's very likely to fall-- annuitants live longer than average, and longevity is growing at a shocking pace at the moment).

They are valued the same way any financial asset is -- by projecting expected cash flows (incorporating life expectancy in this case) and discounting them. You could look at the prices of inflation-indexed annuities, which do incorporate some profit for the insurer, but they are more relevant if you are about to retire.

There is political risk that Social Security benefits will be reduced, especially for higher income workers -- proposals have been made to have their projected benefits grow with inflation, not average wages. Since state governments, unlike the federal government, cannot print money, there is small but nonzero credit risk in a state retirement plans, just as municipal bonds have credit risk (which is often mitigated by insurance). I have read that many state and local governments, for example the city of San Diego, have made promises that will be difficult to keep.

One more comment, then I'll shut up. The posters who have stated that SS payments are simply income overlook the basic accounting fact that the _right to receive_ future payments is an asset.

I was reminded of this some years ago by an attorney. I receive substantial income from book royalties. The right to my future royalty payments is not only an asset but is an asset subject to estate tax if my wife and I both die before the royalties tail off. The attorney predicted a battle between experts engaged by the IRS and my estate to value this asset. We immediately bought a second-to-die life insurance policy (in an ILIT) to help our heirs pay estate taxes if needed.

David

Ed- What's the purpose of doing it? If it's just curiosity I'd suggest going to the Vanguard web site and quoting out the cost of an immediate annuity with annual inflation adjustments. That's a decent proxy for Social Security. This came up in a recent thread on this group (January

- "Social Security Rate of Return") and for a male in CA of retirement age it was about $230,000 per $1k/month in benefits. If you're not yet at retirement age you might discount that figure back based on years till retirement.

With this type of valuation, Social Security ends up being the most significant asset on most retirees' balance sheets.

-Tad

Well, I can't sell my social security income, so by that standard it is an asset with no value.

But it has value to you.

For example, you could save your entire SS income, and pass it on to your children or other inheritors.

Or you could borrow money, and repay it using your SS income.

In either sense, you have 'sold' your SS income stream.

An income stream is an income stream. The best equivalent is an inflation indexed life annuity, with spousal death benefit. *that* you can buy in the marketplace, so you can use the cost of it as a value benchmark against Social Security.

Near correct answer, but for wrong reason. These are inflation-adjusted immediate annuities. Currently static immediates pay about 7.5% for

Calculate the value of the payments assuming that they are an immediate annuity. See

-- Ron

That doesn't seem right - Social Security and many state retirement plans incorporate annual COLA increases. If you live for 20 or 30 years in retirement, that is a big difference, compared to a plain immediate annuity.

John Cowart

The annual Social Security adjustment goes as the increase in average wage levels (for some rather complex definition of that), not the CPI or other "cost of living" indexes. Historically, this increase has been greater than the corresponding changes in CPI. One of the things currently urged to stave off the approximate 25% reduction in benefits that would occur after the SS "trust fund" inputs are exhausted is to change the adjustment _down_ to the CPI change.

Thus, for getting an estimate of the nominal "capitalization" of your Social Security benefit, you need to throw in an additional factor on top of the premium for COLA adjustments to accommodate this difference, and maybe then a second order negative delta to factor in the political "risk" (the near certainty that _some_ change to the system will be in place in a couple of decades).

You are right. A plain annuity pays about 7% for a 65 year old, while an inflated protected one pays about 5.5% plus annual inflation adjustment.

Yes, but the whole idea of cash value is imprecise. The OP was leaving out any consideration of the retiree's age or health.

One could likewise argue that the cash value of an annuity should be lower because it could be invested in the stock market to get the same income stream.

-- Ron

A participant stated that the annual increase in SS benefits is tied to an index of wages rather than to the Consumer Price Index. That's not correct. The annual index is based on the CPI. To quote from the 2006 Annual Report of the SS trustees:

"For December 2006, the benefit increase is the percentage increase in the Consumer Price Index for Urban Wage Earners and Clerical Workers from the third quarter of 2005 to the third quarter of 2006."

But the _starting point_ for SS benefits _is_ tied to an index of wages. In effect, each age cohort of SS beneficiaries gets higher benefits in real terms than previous age cohorts because wages tend to rise more rapidly than prices. The idea is that SS should roughly replace a constant proportion of wages. The actual process is much more complicated than that: lifetime earnings (up to the annual SS max) are adjusted by an index of wages, then a formula involving 2 "bend points" is applied so that higher earnings get less credit -- SS is an income transfer program that replaces more of the earnings of low-income earners than of better-off folk.

The SS "crisis" (which is trivial compared with Medicare) could be dealt with by indexing starting benefits to prices rather than wages or by fiddling with the bend points to pay less to higher earners, or by raising the max income subject to SS tax, or by combinations of these or other mesaures. Because the "crisis" is still a few years off, there's no political will to do anything now. So more drastic measures will eventually be required.

David

Thank you for that correction.

That doesn't seem right either - an immediate annuity represents not just an earnings stream, but also (eventually) a return of principal, a feature not usually present in stock investments.

According to

Immediate annuities only guarantee the income while you're alive. There are some variations like joint survivorship or a minimum time guarantee.

-- Ron