For many of us, the hard-earned right to receive future social security benefit payments potentially constitutes a significant portion of our planned retirement income. For those of us in the pre-retirement years, we look with interest at the Social Security Statement we receive every few years giving us our expected monthly income from social security if we were to retire at certain defined ages. But have you ever given any thought to the present dollar value of your right to receive those future benefits? Did you know that current and future interest rates mean a great deal in that calculation? Let’s look into that a little further.

One of the most significant outcomes of the recent financial crisis has been the decline in interest rates. The lowering of rates has been orchestrated in large part by the Federal Reserve as a method to encourage lending and increase capital spending by lowering the cost of credit, part of the “grand experiment” of government intervention in the economy. Currently, interest rates are at historically low levels and if you listen to the Federal Reserve, interest rates should remain low until at least 2015.

“Present Value” means the value today of a future payment or stream of payments, discounted at some appropriate compound interest. A key component in this is the current and immediate projected rates of interest. If you were to receive $10 today and invest it, you would expect it to be worth more in five years. Conversely, your right to receive $10 in the future would be worth less than $10 in present value. For that reason alone (and of course for many other reasons), it is never too early to start saving and investing for retirement.

When interest rates are low the present value of future income streams such as social security payments increases. The lower the interest rate is, the higher the present value of those future payments is. Today, that makes the present value of your future social security benefits a very valuable asset.  This clearly highlights how valuable, in present value terms, your social security benefits are. But like all human beings, now you probably are thinking “that’s interesting, but how can I get even more?” Of course when we say more, we always mean more net after tax income.  

Some methods of increasing social security payments are delaying payments, having only one spouse elect payments while the other delays, and of course many more. Also, avoiding distributions from tax generating accounts, such as other retirement plans, is another way to maximize your net after tax social security income. There are a variety of things that can be done to maximize the amount you receive in social security benefits.

If you are fortunate enough to be a participant in a defined benefit plan, the same logic applies. The present value of those future payments is now very high. This means that those making a lump sum versus periodic payment decision may never have a higher lump sum option.

And of course these low interest rates can affect other retirement accounts also, such as IRAs, 401(k)s and other types of defined contribution accounts and plans. If invested in conservative, interest rate bearing instruments, those low present and projected interest rates dictate that a much larger amount needs to be invested in order to achieve your desired future retirement income.

So what should you do in way of reviewing your retirement readiness in light of some of the information here? First, contact your South Coast advisor. Review your retirement income needs and update your plans for retirement, keeping the value of your social security income benefits as an integral part of those plans. Make sure that you are saving enough in retirement and supplemental retirement accounts.

-Posted by Jeff