Understand Your Social Security Benefits

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Social Security benefits will help make you rich. Retirement in our country changed forever after 1935. Since federal Social Security laws were enacted citizens who have work throughout their life can expect a guaranteed income after retiring.

When lifespans were shorter and retirement years were brief there was plenty of money to send those few elderly. Now there are fewer workers per elderly retiree and the system is being strained. Nevertheless, it is a great benefit to understand. Social security provides monthly guaranteed income for life. It also gets adjusted upwards with inflation.

Will Social Security Even Be Around?

Doctors sometimes dismiss Social Security altogether. They think the amount will be too small to be important. Or they think the system will be bankrupt or nonexistent at their retirement time. I think neither is the case. Although Social Security income is unlikely to provide a full income replacement in retirement for the average physician, it will be there. Social security is a Federal legal obligation and is sustainable going forward as a transfer payment system. When you are young and working you pay some of the elderly retirees. When you are old and retired, younger workers pay you.

It is a misconception to think you paid into a fund and then the money will come out of that fund for you later. That misconception is what drives fear about the fund running out and being bankrupt.

Fewer Young Paying for More Old People

There are fewer workers supporting more elderly over time. Fertility and immigration have declined. Longevity has increased. Workers retire. This mix is straining the Social Security system. But straining doesn’t equal destroying. Congress has already acted to make it more sustainable. One example was making 67 the new full retirement age (FRA).

Will Social Security Provide Enough to Matter?

Yes. An additional 30K – 70K per year counts. That money is consistent and guaranteed by the U.S. Government. That is nothing to sneer at. Now that pensions have been scrapped for almost all of us, steady guaranteed income like Social Security is even more important. It won’t cover all of your spending needs. But nor should it be dismissed and ignored. Doing so may require you to work longer than you need under the assumption your portfolio will need to be bigger to cover all your spending.

Equities Outpace Inflation

Many of us have inadequate equity investing. We may be overly conservatively invested for the long haul. Stocks tend to consistently provide growth well above the inflation rates over long periods of time. Short-term fluctuations in stock prices, however, make many of us nervous. Because of our fear and anxiety, we carry too low a percentage of equity in our asset allocation. It is just one example of the many ways in which our psychology and behavior make us poor at investing decisions.

You Own a Social Security Bond

One way to become more comfortable with a larger percentage of equity investing would be to consider your fixed income in a broader context. Social Security income is basically a guaranteed pension that is backed by the US government. It is also inflation adjusted. This is an excellent annuity and is comparable to having a large investment in fixed income securities with much less risk. So, basically, you have more bonds than you realized.

When adding up your fixed-income investments, consider adding your future Social Security as a single lump sum investment rather than as a monthly income stream. I thank Darrow Kirkpatrick for making this concept clearer to me in his excellent book, “Can I Retire Yet?” Mr. Kirkpatrick has a lot of credibility with me since he successfully retired at age 50. He does not argue strongly that we should adjust our asset allocation based on Social Security as I am arguing here. But he clearly understands the concept and illustrated the calculations in his book.

How Does This Work in Practice?

The example he gave was an expected Social Security benefit of $2500 per month. That is $30,000 per year. How much money would you need to have to generate that much income through passive investing? We can use the 4% safe withdrawal rate. If you multiply $30,000 per year times 25 that equals $750,000. That is the amount you would need in a portfolio to produce $2500 per month – like what will be coming in through Social Security is a guaranteed income.

We then need to make a couple of adjustments. Since the income is at a future date, we need to discount that amount to the present value. He suggested using a rate of return of 3%. If the working couple in the example are 50 years old and they plan to receive Social Security in 20 years, the present value would be $415,257 (=PV(3%,20,0,-750000))

Let’s Make it Conservative

Because it is difficult to predict all of the economic cycles, political shifts, reduction in benefits, means testing criteria, etc. we could make this estimate more conservative by taking 25% off the total. 75% of future Social Security may be a more reasonable figure over such a long time. That means the conservative amount in today’s dollars would be $311,443 (75% of 415K).

Early Retiree Social Security

Let’s say in my case I am 50 years old and will retire at age 70. First – as an aside – why would I not take Social Security at the earliest opportunity? Let’s say age 62? At age 62 I would receive $1953 per month. If I delayed taking Social Security until age 70, I would receive $3609 per month. We often quote that we receive 8% per year return by delaying Social Security. Although that is true, it minimizes the magnitude of this effect. By starting at age 70 rather than 62 I would receive 85% more income. Furthermore, the income stream is inflation adjusted and guaranteed for life!

I’m a Social Security Millionaire

So back to my example. $3609 per month is equal to $43,308 per year. This would start in the year 2037. What amount of investable assets would be required to produce $43,308 per year using the “4% rule?” The answer is revealed by $43,308 times 25 which equals $1,082,700. Holy smokes. Social Security is extremely valuable.

Now let’s make a couple more adjustments. Since this income is 20 years away, we can discount it at 3% as in the prior example. This yields an equivalent investable asset amount of $600,000 (=PV(3%,20,0,-1082700)). If we conservatively estimate only three-quarters of this amount, that is still $450,000.

Social Security Asset Allocation

How could I use this concept to better understand and adjust my asset allocation? Let’s say I have a $2 million portfolio. $1 million of bonds and $1 million of stock. My asset allocation with regards to equity is therefore 50% (1,000,000÷2,000,000). If I add in the $450,000 from the equivalent Social Security as an annuity/bond, the ratio would change. This would better reflect my actual risk level. My equity percentage would then be 41% (1,000,000÷2,450,000).

If you carry out the calculation using your own Social Security numbers at the SSA website, you may have more courage to invest in equities. That one change would likely enrich you in the long haul.

Navigating Social Security

Social Security provides about 1/2 of retirement income for 1/2 of married couples. You likely should also plan on receiving some.

You Pay up to a Point

Employees pay 6.2% of their salary into this system. Their employer contributes an equal amount to total 12.4% This is up to a limit. That limit in 2019 is $132,900. If you are self-employed you need to pay 12.4%, since you are responsible for both the employee and employer portions.

You Didn’t Pay Into Social Security

There is a misconception that we contribute, and that money is saved in a fund that will later pay us back in our old age. It is a government transfer fund. Active workers who are paying taxes now are paying for the current beneficiaries. This is worrisome since there are more nonworking elderly in the future than there are young employees paying the tax. This becomes an increasing burden.

Will The Trust go Bust?

The trust fund is expected to be depleted in the year 2033. What will happen will likely be a reduction in benefits, later retirement ages, and/or stricter benefits testing in order to preserve the fund going forward.

Early Retirement Social Security Problem

To be eligible to receive Social Security you need 40 credits. You can earn up to four credits per year while working. This means you’re really required to work for 10 years before you are eligible to receive Social Security income. How much income you receive depend on your highest earning years. Social Security will look at your 35-year work history. If you have not worked 35 years, zeros will be filled in for years that you did not work. There is a benefit to a long work career since that avoids zeros in your income record.

Waiting Until Age Seventy

If you take Social Security before “full retirement age” your benefits will be permanently reduced. Delaying taking benefits until your Full Retirement Age or beyond to age 70 results in the equivalent of a guaranteed 8% return on your investment. There are other benefits to taking it later. For one thing, working during early retirement will reduce your Social Security income during those years.

As a spouse, you are eligible for a benefit from being married to a wage earner as defined by social security. The spousal benefit is worth 50%. Thus, a married couple could take up to 150% of the working spouse benefit.

If you understand all that is in this brief primer, you are way ahead of about 80% of Americans who have limited knowledge of how social security income works. Do you look forward to receiving this guaranteed income stream?  Are you invested in more equities because you own a “Social Security Bond?”

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