Part 1 of this post made the point that Social Security is a retirement asset, specifically, an annuity. Part 2 took this concept one step further and stated that, similar to a commercial annuity contract that has been annuitized, the value of the future payment stream can be calculated and included on every qualified Social Security recipientTM's personal financial statements. The question is, who is a qualified Social Security recipientTM?
There are two types of qualified Social Security recipientsTM when it comes to Social Security retirement benefits: (1) current recipients and (2) future recipients who are vested in their benefits.
Although as stated in Part 2, the valuation of Social Security benefits as an asset isn't straightforward, it's easiest to do for current recipients. These individuals are currently receiving a defined monthly payment. What isn't known and must be determined is (1) the number of payments that will be received going forward, i.e., life expectancy, (2) projected Social Security cost of living adjustments ("COLA's"), and (3) an assumed interest rate. In the case of a married couple where one spouse currently receives or will receive 50% of the other spouse's benefit, the 50% spouse's life expectancy must also be determined.
Future Recipients Vested in Their Benefits
For those of you who participate, or who have participated, in defined benefit pension plans, you're familiar with the concept of vesting. Simply stated, vesting as it pertains to pension plans, is the non-forfeitable right to receive a defined benefit based on one's salary and the number of years of service performed by an employee. How do you vest, or qualify, for Social Security retirement benefits? Assuming that you were born after 1928, you need 40 quarters, or 10 years of work and associated payment of Social Security taxes.
Once you hit the 10-year mark, you become vested in Social Security. At this point, although it isn't likely to be your actual starting benefit, an estimated retirement benefit can be calculated based on your earnings to date. Each year, the Social Security Administration mails statements to all American workers age 25 or older who aren't yet receiving Social Security benefits approximately three months before their birthday. Each statement includes an estimated retirement benefit for three different retirement ages: (1) age 62, (2) full retirement age, or "FRA," which varies from age 65 to 67 depending upon when you were born, and (3) age 70.
In addition to the age at which you start receiving benefits, your actual benefit payment will be based on the 35 years in which you earned the most. The closer you are to age 62, the more likely the benefit on your Social Security statement will approximate your actual starting benefit. Whether you're 30 or 60 years old, assuming you've worked for 10 years and paid Social Security taxes, a defined benefit is determinable and readily available.
While your actual benefit is likely to be much greater than what is shown on your statement if you're 30 years old assuming that you will continue to work for several years, in my opinion, this is the figure that should be used to calculate the current value of your Social Security benefits for inclusion as an asset on your personal financial statement. Future salary increases, although likely, should be ignored for purposes of this calculation. A basic principle that is used in the preparation of any financial statement, whether it be for business or personal purposes, is conservatism. Since there's a possibility, although not likely, that even if you're 30 years old, your current estimated Social Security benefit will be your actual starting benefit, this amount should be used since it's known and non-forfeitable pending future potential changes to the Social Security system, itself.
The calculation of the value of Social Security benefits for a future recipient vested in his/her benefit is more complicated than for a current recipient. In addition to the three variables listed above for current recipients that must be determined to calculate the value of Social Security benefits, future recipients must also project their retirement age. This is used for to calculate two values: (1) the projected value of retirement benefits at retirement age and (2) the current value of #1.
Whether you're a current or future recipient vested in your benefit, the calculation of the current value of your Social Security retirement benefits is referred to as determining its "present value." Present value, as defined by Wikipedia, is the value on a given date of a future payment or series of future payments, discounted to reflect the time value of money and other factors such as investment risk. While the calculation of present value of Social Security benefits is complicated, it can and should be done for every qualified Social Security recipientTM with the resulting value included as an asset on the individual's personal financial statements.