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People often worry about how much they should save for retirement and whether they’ll run out of money in retirement. Yet, they overlook a key source of retirement income and how much it is worth to them.
Social Security is something many people take for granted and underestimate its value. As I say in my news book, Where’s the Money?: Secrets to Getting the Most out of Your Social Security, that’s probably a significant reason people don’t take the time to make the right decisions about claiming their Social Security retirement benefits.
Social Security retirement benefits are paid monthly and benefit estimates are expressed as a monthly payment, so most people focus on that monthly amount. The monthly benefit can seem like a helpful amount of money but not a large sum. The average Social Security benefit in 2020 was $1,503 per month, and the maximum payment to a beginning beneficiary was $3,011. Multiply the monthly benefit by 12, and the benefit starts to seem meaningful. Multiply that amount by a retirement lasting 20 or 30 years or long, and you start to see the real value.
Also, unlike most annuities, pensions and bond interest, Social Security benefits are indexed for inflation each year. When the CPI rises, your benefits are increased.
Another overlooked factor is that the monthly benefits are guaranteed for life, no matter how long you live and no matter how the investment markets perform. Those last two points are significant advantages that most people aren’t aware of or discount the value of.
The present value of that stream of payments, which would be the amount needed to purchase an annuity with those features, is a significant amount.
Consider how large of an investment portfolio would be needed to generate the level of income paid by Social Security. A married couple receiving average benefits would receive jointly over $36,000 annually. To generate an annual income of this amount they’d need an investment portfolio of more than $1 million, and they’d have to invest it to earn about two percentage points more than the inflation rate. Even then, the investment return and safety of the principal wouldn’t be guaranteed.
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If the couple were to use claiming strategies that optimize their benefits, they would increase their lifetime benefits. They would need a nest egg of $1.5 million or more to produce the same cash flow as the optimized benefits. To purchase an annuity from an insurance company to generate the same inflation-protected stream of income guaranteed for life would require even more money.
Because few people do this analysis or determine how much money they would need to buy a commercial annuity with the same features as Social Security, most people don’t realize they are Social Security millionaires or see how much the value would increase if they took the time to learn how to maximize their benefits.
Knowing the full value of your Social Security benefits is important to developing a retirement plan. You might realize that you don’t need to save as much as you thought for retirement. Also, when analyzing your asset allocation, a lifetime annuity such as Social Security should be considered to be similar to owning bonds or other conservative fixed-income investments. After including Social Security as part of your asset allocation, you might conclude that you can be more aggressive with your investment portfolio and perhaps earn higher returns over time.
Whether you’re retired or planning for retirement, Social Security should be properly valued and integrated into your retirement plan.