Part 1 of this post last week made the point that Social Security, which has historically been taken for granted as a retirement income source, is also a retirement asset, specifically, an annuity. The post explained how Social Security, while not in strict compliance, comes pretty close to fulfilling most of the various attributes of an annuity.
If Social Security is, in fact, an annuity, then why isn’t it included as such on personal financial statements? If you own a variable or fixed annuity that hasn’t been annuitized, the life insurance company from whom you purchased your annuity periodically makes available to you a statement that includes the current value of your investment as of a specific date. The annuity and its value is routinely included as an asset in the nonretirement or retirement section of your personal financial statement, depending upon whether it’s nonqualified or qualified. Nonqualified annuities are generally owned by individuals whereas qualified annuities are owned by retirement plans, including 401(k) plans, traditional IRA’s, SEP-IRA’s, Roth IRA’s, etc.
What happens to your asset when you complete a form instructing your life insurance company to exchange the value of your investment for an ongoing irrevocable structured payout, generally monthly, with a specified number of payments or for the duration of your lifetime and potentially your spouse’s lifetime in the event that you predecease your spouse, i.e., you annuitize your annuity? Similar to your experience when you purchase a new car and it immediately loses an ascertainable amount of its value the moment you leave the car dealer, your $100,000 annuity is diminished in value the moment you receive your first annuity payment.
Just like your new car, while its value is reduced, your annuitized annuity nonetheless has a definable residual value. Unlike your car which may only be worth 85% of what you paid for it the moment after you drive it off the lot, depending on a multitude of factors, the value of your annuity could retain 99% of its previous value after receiving your first annuity payment. The diminished value of your car can be readily determined through an online service such as Kelley Blue Book and included on one’s personal financial statement. The calculation of the value of an annuitized annuity is more difficult, however, and, as a result, while it should be, it isn’t always included on personal financial statements.
Furthermore, once you annuitize an annuity, most life insurance companies cease to provide you with a statement showing you the remaining value of your investment. Why is this? Three reasons: (1) The life insurance company, while it is contractually obligated to make periodic payments to you and potentially to your survivor in the event of your premature death for a specified period of time, unless you elect some type of refund option, it generally is no longer required to return the value of your investment to you in the form of a lump sum payment, (2) The calculation of the remaining value of your annuity is complicated, requiring development and ongoing refinement of assumptions about interest rates and number of potential payments in the case of a lifetime payout, and (3) Aside from highly-skilled, technical, and experienced financial professionals who are always looking out for their clients’ best interests and who, like myself, understand and appreciate the importance and value of this information, there is currently little demand for it.
You’re probably wondering how this relates to Social Security. Unlike a traditional annuity, even though you’re investing in a future annuitized stream of payments via Social Security withholding in the case of an employee and self-employment tax in the case of a self-employed individual, while you receive an annual statement with the amount of your projected monthly benefit, Social Security Administration doesn’t provide you with a statement showing the current value of your investment. Nonetheless, similar to a commercial annuity contract that has been annuitized, although it isn’t straightforward, the value of the future payment stream can be calculated.
Even though the calculation of the current value of one’s Social Security benefits is further complicated by the uncertainty of the remaining duration of Social Security Trust Fund assets, in my opinion, it should be done routinely and the resulting value included as an asset on every qualified Social Security recipient’s personal financial statements. Who is a qualified Social Security recipient? Read Part 3 next week to find out.
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.