If you’re like most working Americans, you will be entitled to a Social Security benefit when you reach age 62. The formula for calculating an individual’s benefits is fairly complicated, involving “average indexed monthly earnings” and “bend points”, but the inputs are rather simple — it is based on the number of [high earning] years worked (up to 35) and the amount of income earned each year. The amount of the entitlement also grows each year that benefits are delayed beyond age 62, until the maximum potential Social Security benefit is earned at age 70. For those that claim their benefit at “full retirement age” (age 66 for those born between 1943 and 1954), the maximum potential monthly benefit is $2,861 in 2019, although the typical benefit is about one half of that figure (around $1,400 / month).
While Social Security payments share some similarities with bond interest payments, they are more akin to a “single life” annuity for unmarried retirees or a “joint and 100% survivor” annuity for married retirees. The benefit payments are also indexed to inflation (called Cost of Living Adjustments) which make them more valuable than a simple fixed income annuity. In fact, Social Security can often be the most valuable single component in a new retiree’s portfolio, even for those with significant retirement savings. How valuable? It turns out, if you know your expected monthly benefit, there is an easy way to get a rough estimate of the total lifetime dollar value of this benefit to you.
Let’s illustrate the value of Social Security using an example of a single woman who claims Social Security benefits today at age 66, which is also her “full retirement age”. According to the 2016 Social Security life expectancy tables available at www.ssa.gov, the average life expectancy for females at age 66 is 85.7, which equates to 19.7 more years of expected life. This means she can expect to receive [19.7*12] ~ 236 monthly payments from Social Security. I’ve reproduced some of the figures from the 2016 Social Security Life Expectancy Table below:
To keep the math simple, let’s assume her monthly benefit at FRA begins at $2,000 / month. After discounting the future monthly payments using US Treasury yield curve rates and incorporating expected rates of inflation over the next 20 years, we arrive at an estimated dollar value of $444,064 today. In other words, her benefit at age 66 is worth approximately 222 times her beginning monthly payment. [$2,000 X 222 = $444,000].
You can calculate this ‘multiplication factor’ yourself because it is roughly 11.2 times your life expectancy. For example, if your benefit were $2,500 / month, and you expected to live for 25 more years, the value of your Social Security benefit would be approximately $700,000 since 25 X 11.2 X $2,500 = $700,000. To be sure, there are more accurate ways to estimate the dollar value of Social Security, but with just these two inputs (your life expectancy and beginning monthly benefit) this basic formula should give you a quick estimate of the value of Social Security to your retirement plan.