With 401(k) accounts taking big hits in 2020 and 2022, Social Security will play a more prominent role in the income planning for pre-retirees within ten years of retirement. With the lifetime value of benefits topping $1 million for a married couple, Social Security has become a very material retirement asset for many people. Without the proper planning, it is not inconceivable that tens or even hundreds of thousands of dollars could be left on the table.
The mistake most people make is to wait until they are at the threshold of retirement to choose their Social Security benefit option. When they realize there are more than 180,000 alternative collection options, they may wish they had more time to plan. Between the system’s complexities and the incredible degree to which benefits can differ based on individual circumstances, most people are not prepared for the number of mind-numbing minutiae involved in exploring their options.
Yet, unlike choosing Medicare options, which can be changed every year, once the choice of Social Security options is made, it is locked in for life.
Social Security as a retirement asset
Less appreciated, and therefore often ignored as a critical planning issue, is the value of Social Security as a retirement asset and its impact on other assets in a retirement portfolio. The fact is, Social Security payments are significant enough that, for the average beneficiary, it would require an asset worth several thousand dollars to replace it. For most people, that would comprise a significant portion of their total net worth.
However, unlike other assets, the unique investment characteristics of Social Security make it a highly desirable asset, capable of providing a hedge against many of the risks associated with retirement portfolios. Because the value of Social Security benefits increases when the value of retirement assets decreases, it is considered a hedge against the rest of the retirement portfolio. Also, because the value of Social Security is calculated based on life expectancy, its value increases further for people who live beyond life expectancy. And, because its payments are inflation-adjusted, its value increases even further during periods of higher inflation.
The bottom line is Social Security should be viewed as an asset allocation tool that can form a natural hedge for a retirement portfolio. Although it can’t be treated like liquid assets, which can be managed based on changing assumptions, the bond-like Social Security asset can and should play a key role in spending and income distribution strategies, including determining the best time to start taking benefits. With that kind of hedge in place, it could make sense to maintain a higher exposure to equities until benefits begin at age 70 and beyond.
Incorporating Social Security into portfolio and income planning requirements
The type of retirement income planning required to account for the role of Social Security as a portfolio hedge or to maximize income must start well before your anticipated retirement date. There are numerous factors to consider that can impact portfolio decisions before and after retirement. With hundreds of thousands of dollars at stake, a planning delay can prove very costly.
The more guaranteed income you have, the less you need to rely on market conditions to produce the rest. Guaranteed income consists of Social Security benefits, pension benefits, annuity income or any income received that’s not impacted by market factors, such as interest rates or stock market returns. As a rule of thumb, it’s recommended that you have between 30 and 50 percent in guaranteed annual income.
From there, you can more realistically determine how much income you will need to draw down from your investment portfolio to fill the gap. That will also guide you in how to properly allocate your assets to create a reliable stream of income while ensuring continued growth and preservation of your assets.
Seek Social Security and retirement income planning guidance
Planning for lifetime income sufficiency in retirement is much more challenging than planning for the accumulation of retirement assets. There are tax implications and several factors, such as inflation and investment performance, that must be considered. Often neglected in retirement income planning is the role Social Security can play in maximizing retirement income and as an investment hedge. With your financial security at stake, it would be essential to work with a qualified financial professional to develop a comprehensive retirement income plan.
Considering Social Security in your retirement income is important in planning that you have enough lifetime income. Work with a financial professional to develop a retirement income plan that works for you.
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