Are you hoping to retire one day with enough income to live comfortably in your golden years? Where will that income come from when you finally quit working? Social Security forms one leg of the “three-legged stool” of retirement planning -- Security benefits, personal savings, and employer-based retirement plans.
Employers have increasingly replaced defined-benefit pension plans with defined-contribution plans such as 401Ks in which the employee bears the risks of losses in the value of his or her retirement account. However, one way to create long-term income from personal savings is by purchasing an annuity. While an annuity can turn “static” investments into an income stream, these are complex financial products with many variations and conditions.
An issue paper released in May 2017 by the Social Security Administration provides an overview of Social Security retirement benefits and the private annuity market, by comparing and contrasting the two sources of retirement income. Private annuities share some similarities with Social Security benefits. Both provide a stream of lifetime income that can help maintain a person's standard of living throughout retirement. However, there are substantial differences between them.
While Social Security provides benefits for survivors and fully indexes benefits each year to inflation, private annuities charge a higher upfront premium for similar protections. In addition, Social Security provides benefits that are not available in the private annuity market, such as benefits for ex-spouses and minor children. Unlike private annuities, Social Security does not pay different benefit amounts to men and women because of their differing life expectancies. Lastly, the interest rate at the time of the annuity purchase affects the annuitant's monthly payment. In comparison, Social Security bases the retirement benefit on an individual's earnings and the age at which the individual claims benefits. The benefit can be calculated based on those factors alone.
For example, the paper shows that, for a 65 year old man, the average SS benefit in 2014 was $1,317 per month. To purchase a lifetime annuity with that payout, the same man would pay $263,043 and, for 3% inflation protection (which SS retirement provides), the upfront premium would be $359,045. For a 65 year old woman, the average SS benefit in 2014 was $1,033 per month. To purchase a lifetime annuity with that payout, the same woman would pay $229,262 and, for 3% inflation protection (which SS retirement provides), the upfront premium would be $321,954. So that is apparently what a person’s Social Security benefit is worth in SSA’s eyes.
The issue paper (found online at https://www.ssa.gov/policy/docs/issuepapers/ip2017-01.html) explains various types of annuities and the comparative taxation of annuities and Social Security benefits. As employer-sponsored retirement plans continue to shift from defined-benefit pensions to defined contribution plans, it is important for individuals and policymakers to understand both the significance of a steady income stream throughout retirement and the pros and cons of the various sources of retirement income.