Author Topic: How to account for social security when calculating FI date?  (Read 4898 times)

DaKini

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Hi there, sorry if this was already answered. I was probably not succesful at using the search function. Maybe the topic is also useful in the future.

What i wonder is how i can factor in my SS and my small pension into my FI estimate: I will have two additional cashflows starting when i reach 67. The ammount is uncertain and depends on how many years i will stay in my job.
For the estimate i get a yearly overview on how much money i would receive if i would stop working now.
My main problem is, how can i factor in that the cash inly flows at 67 leaving a gap between real retirement and retirement age?

Half-Borg

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Re: How to account for social security when calculating FI date?
« Reply #1 on: June 02, 2014, 04:52:07 AM »
It depends when you want to retire.
I usually don't include it at all because I plan to retire at ~35, if my money last 32 years, it's gonna last another 20 so I don't depend on SS anyway.
If you're older you can retire with a higher SWR, like 5-6%

The common FIRE calc around here can also account for SS

boarder42

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Re: How to account for social security when calculating FI date?
« Reply #2 on: June 02, 2014, 05:33:14 AM »
Yeah i just assume no SS.  I need my money to last upwards of 70 years with the advancement of medicine when i retire at 35-40.  will be an awesome bonus when it starts rolling in.  and will allow me to up my charitable contribution or give my kids more (IF we have kids) 

nereo

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Re: How to account for social security when calculating FI date?
« Reply #3 on: June 02, 2014, 07:45:53 AM »

My main problem is, how can i factor in that the cash inly flows at 67 leaving a gap between real retirement and retirement age?
A couple ways of doing this, from very easy to a bit more complicated.
As the two previous posters have said, one method is to ignore SS entirely, and then anything you do get is a bonus.  This works well for people that plan on retiring 15+ years before any SS disbursements, because they'll likely not be relying on SS at all - in effect this treats SS as an extra layer of safety. I should note that this is my plan also.

Another method is to estimate how much $ you need to reach your disbursement age (in your case 67), and then do a second calculation for what you will need after you begin taking SS.  Many people here go with the 4% SWR rule to determine how much money you can take from your portfolio every year, forever (with a ~90% historical success rate).  Depending on your projected spending rate and SS payments, you may find that this number is relatively small, for example if you only need $15k after SS payouts, a 4% SWR means you need only $375,000 after you turn 67 to maintain your spending level.  In effect, what you are doing here is calculating how much you need on your retirement date you need to have $X at age 67.  This strategy can be useful if you have a shorter time frame (<10 years) and/or if you plan on working part-time until you hit you SS age. 

You can get your estimated SS payouts here: http://www.ssa.gov/oact/anypia/anypia.html
You can run simulations of how hypothetical portfolios would have held up across every market scenario here: http://www.firecalc.com

Finally, it's worth noting that SS payments may not be "as advertised" because of a simple thing I like to call "math".  I don't believe the dooms-day critics that think there will be no SS, nor do I believe the shining-happy-people who think it will somehow be perfect with no changes.  Most estimates put SS payments at ~75% of promised benefits from ~2034 onwards unless we (Congress) makes slight changes.  So, I use only 75% of my projected benefits for my own calculations.  Others undoubtedly will have their own methods.

vespito

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Re: How to account for social security when calculating FI date?
« Reply #4 on: June 02, 2014, 10:23:34 AM »
I have made the very unscientific (and lazy) decision to allocate any SS payments to healthcare.  In a nutshell, I do not count SS towards my FI date.  I am planning on it  partially covering increases in medical expenses.  I'm relatively healthy but I'll probably need to allocate more money to healthcare starting in late 60's.

Gin1984

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Re: How to account for social security when calculating FI date?
« Reply #5 on: June 02, 2014, 10:31:51 AM »
I have made the very unscientific (and lazy) decision to allocate any SS payments to healthcare.  In a nutshell, I do not count SS towards my FI date. I am planning on it  partially covering increases in medical expenses.  I'm relatively healthy but I'll probably need to allocate more money to healthcare starting in late 60's.
Lol, me too!

Rural

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Re: How to account for social security when calculating FI date?
« Reply #6 on: June 02, 2014, 11:59:28 AM »
OP, is this American or German social security you're considering?

Dee18

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Re: How to account for social security when calculating FI date?
« Reply #7 on: June 02, 2014, 01:20:28 PM »
Firecalc allows for all of that... and allows you to say whether any pension has a cost of living adjustment or not. 

Heart of Tin

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Re: How to account for social security when calculating FI date?
« Reply #8 on: June 02, 2014, 03:44:50 PM »
There are a few formulas and concepts you can use to estimate this value if you're willing to assume constant and known inerest rates.

For instance, we can use the all purpose formula PV = R/SWR to find the estimated value of your total expenses in retirement and the estimated value of your pension. Then we simply discount the value of the pension for the number of years between retirement and when you qualify for the pension and subtract that amount from the value of your expenses, and voila we have an estimated amount needed to retire. There is some complication with whether or not the pension is inflation adjusted and whether the amount of the pension increases over time, but I'll work examples below starting with the simplest case and working to more complicated cases.

We will start with my basic assumptions. Let's assume that I am a 52-year-old worker with a $325,000 investment portfolio and investment contributions of $50,000 per year with estimated expenses in retirement of $30,000 per year. I have a pension that is inflation adjusted and will be $10,000 per year (in today's prices) starting when I am 67, no mattter how much longer I work. My safe withdrawal rate is 4%. I assume that my investments will return an inflation adjusted 7% per year.

When will I be able to retire under these assumptions? First I need to price my expenses. Using basic back-of-the-napkin formula mentioned above, my expenses are valued at $30,000/.04 = $750,000. Likewise, my pension will be worth $10,000/.04 = $250,000 when I reach age 67. Since the pension is inflation adjusted both from now until age 67 and after age 67, I need to discount the value of my pension for the number of years between retirement and age 67 using my SWR. Let my age at retirement be called n. At retirement my pension will be worth $250,000 * (1 - .04)^(67 - n). My investment portfolio, on the other hand, will be worth $325,000 * 1.07^(n - 52) + $50,000 * (1.07^(n - 52) - 1)/.07. Now I simply need to find a value of n for which the value of my pension plus my portfolio value equals $750,000. For n = 52, the pension is worth $135,521.60 while my portfolio value is $377,750 for a total value of $513,271.60 which is short of the $750,000 needed to retire. If n = 55, then the pension is worth $153,177.40 while my portfolio value is $559,207 for a total value of $712,384.40. n = 56 results in a total value of $787,911.30, so I estimate my retirement date to be some time between age 55 and age 56.

What if we assume that my pension will be inflation adjusted after retirement, but I will only receive a nominal $10,000 per year at age 67?

In this case, the only factor that has changed is the value of my pension. Since the pension will still be inflation adjusted past age 67, the value of the pension at age 67 remains unchanged at $250,000. However, instead of discounting this amount at my SWR, I need to discount at an inflation adjusted rate. I will assume an effective inflation rate of 2.5% per year. The discounted value of my pension at retirement is consequently $250,000 * ((1 - .04)/(1 + .025))^(67 - n). If I plug in age 56 as above, I get a total value of $746,743.80, just short of my $750,000 goal. So I estimate that I will need to work to some time around age 56 under these new assumptions.

What if we assume that my pension will be a nominal $10,000 per year if I retire this year, but it will increase by a nominal $1,000 per year per year that I continue to work from now until age 67 at which point it will be inflation adjusted only?

Again, the only value that has changed is the value of my pension. However, this time that change is to the value of the pension at age 67. Instead of $250,000, the value of my pension at age 67 will be ($10,000 + $1,000 * (n - 51))/.04. Plugging this into my formula for the discounted value of my pension at retirement will be ($10,000 + $1,000 * (n - 51)) / .04 * ((1 - .04)/(1 + .025))^(67 - n). Now the total value at n = 56 is $805,939.90, overshooting my $750,000 goal. I can again estimate that I will retire between ages 55 and 56.

Finally, what if my pension, while retaining most of the charactaristics of the last example, is not inflation adjusted past age 67?

In this case, we must add in the inflation factor to the value of the pension at age 67 giving us a value of only ($10,000 + $1,000 * (n - 51))/(1 - (1-.04)/(1+.025)). The value of my pension at retirement is then ($10,000 + $1,000 * (n - 51)) / (1 - (1-.04)/(1+.025)) * ((1 - .04)/(1 + .025))^(67 - n). The total value at n = 56 is now only $740,368.80. I estimate that I can retire some time between ages 56 and 57.

I think that covers a sufficient number of cases and concepts that you can tease out the right formula for your specific situation. Note that if the pension is very far away, then it will probably be next to worthless in these formulas. Also, the above are mere estimates; the real stock market does return a constant, real 7%.

DaKini

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Re: How to account for social security when calculating FI date?
« Reply #9 on: June 03, 2014, 03:59:46 AM »
OP, is this American or German social security you're considering?
Sorry for not clarificying that, it is a german ss  along with a small private (but mandatory for me) insurance which is coupled to my ss retirement usage. I can thus only claim it if i claim my ss whichnis regulated by law.

Using it as a safety buffer is what i do currently but it would be nice to know when i could technicylly retire so as i can say "from now on, i just work for my safety margin".
The discounting thing sounds very good for me and i will try that, thank you heart of tin! I already heard from it yet did not know how it works. Your example is very enlightening.