Do you have an investment that will pay you guaranteed lifetime income totaling $870,000 to $1.87 million? This is the projected range of income that my wife and I expect to receive from Social Security during our lifetime based solely on my earnings record depending upon when I choose to start my benefits and how long both of us live. Granted that my earnings have exceeded the taxable Social Security wage base for most of my working years, however, this isn’t unusual.
Our projected benefits assume that (a) my current earnings level continues until I begin receiving Social Security, (b) either my wife or I live until at least my age 90, (c) my wife potentially lives until age 95, and (d) Social Security cost-of-living adjustments (“COLA’s”) are 2% each year which is less than the average increase of 2.6% over the last ten years. If all of these assumptions are realized, our actual benefits will likely be greater than the projected amounts since the projections don’t include COLA’s between now and retirement.
In order to truly appreciate the value of Social Security retirement benefits, it’s important to understand that it isn’t simply an entitlement program. Social Security is instead an investment; in particular, it’s a deferred income annuity (“DIA”) payable for life.
Let’s review a couple of definitions in order to put things in perspective. Per Retirement Income Visions™
Glossary, a Deferred Income Annuity is an annuity for which annuitization begins at least 13 months after the date of purchase in exchange for a lump sum or series of periodic payments. Per the Glossary, Annuitization is the irrevocable structured payout of income with a specified payment beginning at a specified date, paid at specified intervals over a stated period of months or years or for the duration of the annuitant’s and potentially his/her spouse’s and/or other individuals’ lifetime(s) depending upon the payout option selected.
Relating these two definitions to Social Security, in exchange for a series of payments, i.e., Social Security taxes paid by you and your employer, over your working years, you will receive an irrevocable structured payout of income with a specified payment beginning at a specified date paid for the duration of your, and potentially your spouse’s, lifetime, depending upon the payout option selected.
The primary difference between Social Security and a commercial DIA is the organization from which the investment is purchased and payments are guaranteed. In the case of Social Security, it is the federal government while DIA’s are purchased from, and payments guaranteed by, individual life insurance companies.
A second difference is the methodology used to calculate one’s lifetime benefit. Simply stated, Social Security benefits are calculated using a series of formulas based on one’s historical earnings relative to the taxable Social Security wage base in effect during each year of employment. Lifetime DIA payouts, on the other hand, are actuarially calculated using the amount and timing of lump sum and/or series of periodic payments, life expectancy factors, as well as current and projected interest rates.
A third potential difference between Social Security and a commercial DIA is the calculation of the payment amount after the initial year. Although a specified payment beginning at a specified date is calculated by the Social Security Administration based on various assumptions, the payment is the amount payable during the first year of benefits. Subsequent years’ payments can increase depending upon annual COLA’s. DIA payouts can increase as well if contractually provided. In some cases it’s also based on COLA’s, however, most of the time it’s determined by a predefined inflation factor.
Approximately 96% of working-age Americans are covered by the Social Security system. Social Security provides 90% of retirement income for one in three retirees and more than 50% for two in three retirees. Given these facts, Social Security is the most prevalent type of investment in the United States. Furthermore, it is, by far, the most popular DIA available in the marketplace.
Robert Klein, CPA, PFS, CFP®, RICP®, CLTC® is the founder and president of Retirement Income Center in Newport Beach, California. Bob is also the sole proprietor of Robert Klein, CPA. Bob applies his unique background, experience, expertise, and specialization in tax-sensitive retirement income planning strategies to optimize the longevity of his clients’ after-tax retirement income and assets. He does this as an independent financial advisor using customized holistic planning solutions based on each client’s needs and personality.