When clients view Social Security as an asset, portfolios can grow

Like most of my colleagues, I routinely help clients preparing for retirement review their Social Security options. We discuss the advantages of delaying receipt of benefits for as long as possible in order to maximize the guaranteed monthly benefit; we discuss spousal benefits and compare them with what the spouse would receive by claiming on their own; we project life expectancies and estimate what they'll need to draw down from all available sources, including the tax ramifications of each source. 

But I like to take the  additional step of reframing clients' guaranteed income streams — Social Security income and pension income from defined benefit plans, if applicable — as "assets" in the context of their total portfolios. 

We know, of course, that Social Security benefits and pension income are not like the assets in a portfolio: they cannot be bought and sold and once they are initiated they don't change (except for the Social Security Cost-of-Living Adjustment). But helping clients put them on the "balance sheet" can lead to useful conversations about the rest of the portfolio, and especially about developing a draw-down strategy that maximizes the growth potential of other assets and minimizes tax consequences for the client. 

A recent conversation with a friend who will soon retire from a state education system brought home the utility of this approach. Her state maintains a defined-benefit pension system for public school and higher education professionals. At the end of the current school year, she will qualify for full benefits based on her age and years of service. My friend told me that when she read her retirement system's quarterly report she was astounded to learn that the annuitized value of her guaranteed monthly benefit was nearly $1.5 million. It was almost like discovering a treasure chest in her backyard, she told me.

This got me thinking about other sources of monthly income that are guaranteed for the life of the recipient, like Social Security. Even those whose income has been relatively modest throughout their careers can typically look forward to a substantial guaranteed monthly benefit once they begin claiming Social Security. Currently, the average monthly benefit is $1,628.17, amounting to an annual benefit of just over $19,500. Multiply that by the average life expectancy of a person retiring today at full retirement age (67 for those born after 1960), and the total lifetime value of those Social Security payments is $321,555 for men (16.49 years) and $368,355 for women (18.89 years). For higher earners, the numbers are correspondingly larger, since the benefit comes from taxes on earnings.

And here's another interesting bit of analysis. A few years ago, Michael Kitces proposed that the "asset" value of Social Security actually functions as a valuable hedge against factors that can dampen the performance of other portfolio assets. For example, because of the COLA, Social Security benefits become more valuable when inflation is running high — like now, for example. Further, because Social Security benefits are guaranteed for life, their value increases when the returns on risk assets are low, as in a bear market. And because you can't outlive Social Security benefits — or defined-benefit pension income for that matter — their asset value is enhanced for those who surpass the average life expectancy. In the case of someone who lives to age 95 during a period when inflation is averaging 5%, the lifetime value of Social Security benefits can be double the figure shown above, or even more.

This doesn't even contemplate the additional benefit that may be gained by those who are able to defer receiving Social Security benefits until after full retirement age. As many of us routinely tell our clients, you get an 8% "raise" for every year you wait beyond full retirement age until age 70, when the benefit maximizes. So, persons who wait until age 70 to start receiving benefits and who also live beyond the average life expectancy could perhaps triple the "asset value" of their Social Security benefit.

Only 23% of workers say they have given any consideration to the best way to maximize their benefits when claiming Social Security, according to the Employee Benefit Research Institute's 2018 Retirement Confidence Survey. This may indicate that we as financial advisors need to do a better job of helping our clients put their Social Security and pension benefits in the context of their other portfolio assets as they evaluate their sources of retirement income. 

In doing so, we can give them greater confidence as they face retirement and also help them make smarter decisions about their retirement income strategies.