Personal Finance (Not Investing) • Open Social Security Discount Rate In Practice for Early Retirees

I'm new to Net Present Value (NPV) and didn't understand that the NPV of SS (or any annuity, like a pension) that starts in the future will start lower and increase until it peaks the year you get your first payment. As you described, the practical outcome in an AA that takes SS's NPV into account is fewer and fewer non-SS bonds are needed to maintain the AA as SS approaches. As you age and the end of your SS payments draws nearer, SS's NPV gets smaller and you'll need more non-SS bonds to maintain the AA. And in WHY CALCULATE THE PRESENT VALUE OF THE PENSION? you explain how an AA that takes SS's NPV into account maintains a mathematically consistent total portfolio ratio.

Yes, the NPV of a future payout will rise over time when the discount rate is positive. But what's driving the declining bond share during the gap years is the fact Social Security is becoming a larger fraction of remaining assets due to fewer remaining gap years. The following diagram illustrates this:

Future funding needs at age 50:


Future funding needs at age 70:


Social Security is a smaller fraction of future spending at age 50 than at age 70. Because of this, you need a higher fraction of bonds at age 50 than at age 70 to get the same risk on spending. In other words, bonds / (stocks + bonds) is higher at age 70 than at age 50 in the graphs above.

The above may be what Mike Piper is talking about [...]

Yes, the approach of counting SS as a bond is consistent with what Mike Piper is saying when he talks about:

• "swapping bonds for Social Security"
• "spending more quickly from bonds than you otherwise would have done — “selling” bonds in order to “buy” Social Security"
• "shifting the [non-SS] allocation of the portfolio toward stocks"
• "Your household balance sheet includes more than just the stuff in your retirement accounts, [including] your Social Security. And if you have a pension, it includes your pension."

Question #1: Mike's choice of the 20-year TIPS yield is because it's the closest instrument to SS we have -- its yield is a risk-free rate after inflation. And because SS adjusts for inflation too, the SS NPV calculation is in today's dollars, just like the rest of the dollars (the current value of my portfolio) I use to set my AA. So I could use OpenSS's default discount rate, then I could use its NPV calculation for my AA, right?

Yes, if you assume a known max age like age 95. But...

(I like that OpenSS doesn't ask me to guess my "end of retirement" date, but instead uses the SSA's Actuarial Life Table probabilities.)

When you factor in uncertainty about life expectancy, Social Security becomes more attractive than its expected probability weighted payout value because it serves as longevity insurance. So you should value it more than Open Social Security calculates the value to be using raw actuarial life table probabilities. This is mentioned in the about section of OSS. See this post and the subsequent discussion for more.

Question #2: I have a pension that does not adjust for inflation. When calculating its NPV and wanting a value in today's dollars like the rest of my AA, I can start with OpenSS's default discount rate, but I'll need to add an estimated average annual inflation rate, correct?

Yes. You can use the nominal Treasury bond rate to calculate the NPV of a safe nominal pension. This is that same at using the breakeven inflation rate as you inflation estimate because:

nominal Treasury bond rate = real Treasury bond (TIPS) rate + breakeven inflation rate

Statistics: Posted by Ben Mathew — Sat Apr 13, 2024 1:13 am — Replies 10 — Views 1988

---