You Don’t Even Know What You Don’t Know About Social Security

24-Jul-2017

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By Steve Garfink, International Living,

We know that Social Security is governed by a complex set of rules. And, we know that we don’t understand them very well; we know we need to do our research to learn what we don’t know in order to get the most value from our benefits.

However, I want to suggest that there are important aspects of Social Security that most people don’t know anything about—and don’t know that they don’t know anything about.

Let me give you just one example. Do we ever stop to consider how much our benefits are worth? Suppose you recently received a statement about your benefits from Social Security. You find that your benefit at age 66 will be $2,000. (This corresponds to someone who earned about $65,000 annually throughout their career in today’s dollars.)

We have a good sense for what $2,000 a month will buy in goods and services. But what is it worth to us to receive a payment in this amount for the rest of our lives? How does this compare to our savings and retirement accounts, or the value of our equity in our homes?

Let’s find out.

To do so, we can rephrase the question this way: How much would we have to pay someone in order for them to pay us our monthly benefit amount—adjusted each year for inflation, just like Social Security—beginning at our retirement age for the rest of our life?

It turns out that insurance companies offer a product like this called an inflation-protected annuity. They will pay us an amount equal to our benefits beginning at a given age and adjusted annually for inflation—for a considerable fee.

How much? Consider the benefit amount used above of $2,000 at age 66. Someone qualifying for this benefit amount could claim it at 62 when it would be reduced 25% to $1,500; or, wait as long as age 70 to maximize the benefit amount and it would equal $2,640 (plus all the inflation adjustments that were given between age 62 and 70). (The following examples are based on recent online quotes from an insurance company.)

A 62-year-old male would have to pay an insurance company just over $440,000 to purchase this benefit. And that’s the amount he would have to have in regular savings, not retirement accounts where he still owes tax on withdrawals.

For a female of the same age and benefit amount, the policy premium is even higher: just over $473,000. Why the increase? Women live several years longer on average than men, so the insurance company needs the higher premium to cover those extra years of life.

Now consider the premiums we would have to pay at age 70 for the $2,640 benefit. Will it be greater, because the monthly amount is greater? Or will it be less because we collect it for eight fewer years? Or will it be about the same?

For a male who wants a policy that pays $2,640 at age 70, the premium would be just over $586,000. For a female, the premium would be about $644,000. As a married couple, they would have to pay just over $1.23 million to “buy” their benefits at age 70. There are very few baby boomers that have that kind of savings when they retire—probably well under 10%.

When we think about our Social Security benefits this way—by considering their value as if they were savings—we can gain a better appreciation of just how valuable those benefits are to us. For most of us they are our most valuable asset: greater than all our savings and greater than the equity in our homes.

And just as we need to invest a certain amount of effort into managing our savings or maintaining our homes, we also need to do the same for our Social Security benefits. This means making sure that we have fully understood and carefully thought through our claiming options before we sign up.

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