Undecided about when to claim Social Security? If you think of that benefit as a lump sum, as opposed to a stream of payments, the decision might be easier.
That’s among the primary points in a recent article, “Valuing Social Security Benefits as an Asset on the Household Balance Sheet,” by Michael Kitces, director of research at Pinnacle Advisory Group in Columbia, Md. Most people, Mr. Kitces notes, think about Social Security—not surprisingly—as a series of monthly checks. But it’s possible (and fairly simple) to calculate the value of Social Security as an asset in your portfolio.
That calculation, Mr. Kitces writes, illustrates why Social Security is “uniquely capable of hedging many risks in retirement that traditional portfolios cannot”—and he says it argues for “delaying benefits as long as possible.”
People who delay the start of their Social Security benefits give up initial payments but collect “delayed retirement credits” that produce a bigger monthly check once payments begin. From “full retirement age”—which is climbing gradually to 67—to age 70, the benefit goes up each year by 8% of the full benefit.
Here’s how Mr. Kitces digs into the numbers: To start, it’s possible to determine the “present value” of a series of cash payments if we have the size of those periodic payments, a time horizon, and a growth/discount rate. People can find the size of their expected monthly payout from the Social Security Administration; the time horizon is a person’s life expectancy; and Social Security payments, which are backed by the federal government, are akin to a government bond.
Given that, Mr. Kitces offers the following example: an average Social Security retirement benefit (as of 2014) of $1,294 a month, a 10-year Treasury rate of about 2%, assumed inflation of 3%, and a life expectancy for someone who has already reached age 66 of approximately 17 years for a male and 20 years for a female.
The result: The average “lump sum” value of Social Security is about $280,000 for males and $335,000 for females.
(A note about inflation: Social Security benefits are adjusted annually to reflect increases, if any, in the consumer-price index. If inflation is higher, the lump-sum values would be higher; if inflation is lower, the values would be lower.)
Mr. Kitces goes on to illustrate that the value of the lump sums increases—to about $312,000 for men and about $360,000 for women—if a person delays filing for Social Security to age 70.
That might not seem like much. But the increases, as well as the lump sums themselves, are actually larger than they would be in a more “normal” interest-rate environment, where a government bond yields, say, 6%. (At higher growth rates, an investor wouldn’t need as much in assets to produce the same stream of payments.)
All of which makes Social Security “not only a highly valuable asset overall, but one with unique investment characteristics,” Mr. Kitces writes. First, unlike most other assets, its value rises in low-return settings. Second, its value (as noted above) adjusts to the cost of living, which makes Social Security—and, in particular, delaying Social Security—an especially effective inflation hedge. And third, its asset value rises with increased life expectancy, “effectively providing a self-renewing asset that cannot be outlived,” Mr. Kitces adds.
In short, one of the primary reasons to delay Social Security and spend other assets first, Mr. Kitces concludes, is that “the Social Security asset is the one best hedged to the risks that damage most retirements.”