How much is your Social Security really worth?

Social Security is far more valuable than it used to be, and not just because of the 3.6% COLA announced last week. Scott Burns, in his October 2 column, "How Much are Social Security Benefits Really Worth?" asks how much cash you would need to generate the same amount of income that Social Security provides. It's a simple question of present value in the face of lower interest rates.

Back in 2000, when the yield on five-year Treasury obligations was 6.16%, you needed a lump sum of $162,843 to generate income equal to the average Social Security benefit of $840 per month. Today, with yields at 1.0%, you would need $1.4 million to get essentially the same income (the average benefit is now about $1,181).

The dramatic reduction in interest rates has not only lowered the discount rate that makes a future income stream more valuable, it has increased the relative importance of Social Security as a source of retirement income. The $100,000 IRA that would have earned $6,160 in 2000, now earns only $1,000 a year. Higher returns are available elsewhere, of course, but not without risk. The result is that for most people Social Security is likely to comprise a larger slice of the retirement income pie.

Many baby boomers are dealing with the unfortunate math caused by today's low interest rates by continuing to work. So for now, Social Security—for those who have started collecting—still represents a small slice of the retirement income pie. But at some point the earned income will stop. When that happens Social Security will step up to comprise a greater share of retirement income—40%, 50%, maybe even more. And that's when you will be thankful to offices like ours for helping maximize your benefits. By leading clients into decisions that improve their future income stream, my office is adding to your wealth just as if I had increased the value of your retirement and investment accounts.

GAO says benefits from 62 to 66 wouldn't buy equivalent annuity

In their report, Retirement Income: Ensuring Income throughout Retirement Requires Difficult Choices, the Government Accountability Office says that the amount of money a retiree would receive by taking early benefits is less than the amount needed to purchase an annuity that would provide the additional income that would be available by waiting. As the graph below shows, an early claimer who receives $12,000 a year in benefits would receive an extra $48,000 from age 62 to 66. But he'd have to spend $71,000, or 47% more, to buy an annuity that would generate the $4,000 in additional income he would receive by applying for benefits at 66.

***Keep in mind once again the above is dependent on the current interest rate and the outcome might change in a different interest rate environment.

Schwartz Financial Weekly Commentary 10/24/11

Schwartz Financial Weekly Commentary

October 24, 2011

The Markets

“Good news is good and bad news is bad, but a lack of bad news can be good, at least for investors,” so wrote Vito Racanelli in the current issue of Barron’s.

Since the recent October 3 low, the S&P 500 index has risen 12.6 percent on the back of “a lack of bad news,” according to data from Yahoo! Finance.

Here’s what we could classify as a lack of bad news in the past few weeks:

·         Corporate earnings are coming in okay so far this quarter as 75 percent of the 118 companies that reported earnings have beaten estimates, according to financial data provider FactSet.

·         Economic news has generally supported the idea that the economy, while soft, is not collapsing.

·         European leaders, after months of tough talk, but little action, may finally be on the verge of taking “comprehensive” action to quell (at least temporarily) the sovereign debt crisis, according to Phil Orlando, chief equity market strategist at Federated Investors.

Whether this “lack of bad news” turns into good news or bad news going forward, remains to be seen. Either way, we’ll work hard to profit from it.

Data as of 10/21/11	1-Week	Y-T-D	1-Year	3-Year	5-Year	10-Year
Standard & Poor's 500 (Domestic Stocks)	1.1%	-1.5%	4.7%	9.0%	-2.1%	1.3%
DJ Global ex US (Foreign Stocks)	-0.3	-14.0	-11.1	8.1	-3.1	5.3
10-year Treasury Note (Yield Only)	2.2	N/A	2.5	3.7	4.8	4.6
Gold (per ounce)	-2.1	16.5	22.3	28.6	23.0	19.5
DJ-UBS Commodity Index	-2.2	-10.7	0.3	2.0	-2.7	4.8
DJ Equity All REIT TR Index	3.6	1.4	2.3	14.6	-1.8	10.4

Notes: S&P 500, DJ Global ex US, Gold, DJ-UBS Commodity Index returns exclude reinvested dividends (gold does not pay a dividend) and the three-, five-, and 10-year returns are annualized; the DJ Equity All REIT TR Index does include reinvested dividends and the three-, five-, and 10-year returns are annualized; and the 10-year Treasury Note is simply the yield at the close of the day on each of the historical time periods.

Sources: Yahoo! Finance, Barron’s, djindexes.com, London Bullion Market Association.

Past performance is no guarantee of future results.  Indices are unmanaged and cannot be invested into directly.  N/A means not applicable.

THE WORLD’S POPULATION IS EXPECTED TO HIT 7 BILLION on October 31, according to the United Nations’ population division. That’s up from 2.5 billion in 1950. To put 7 billion people in perspective, see if you can correctly answer the following question.

If 7 billion people stood shoulder to shoulder, which of the following geographic areas is the smallest that could accommodate them?

A)  Zanzibar (about 650 square miles)

B)  Maui (about 727 square miles)

C)  Rhode Island (about 1,033 square miles)

D)  Sicily (about 9,925 square miles)

E)   Cuba (about 42,845 square miles)

F)   New Zealand (about 103,733 square miles)

The answer… in a moment.

Here are some interesting facts regarding the rate of growth of the world’s population.

It took…

·         250,000 years for the world to reach a population of 1 billion (hit in 1804)

·         123 years for the next billion (2 billion in 1927)

·         33 years to reach the next billion (3 billion in 1960)

·         14 years to reach the next billion (4 billion in 1974)

·         13 years to reach the next billion (5 billion in 1987)

·         12 years to reach the next billion (6 billion in 1999)

Sources: The Economist; United Nations World Population Prospects: The 2000 Revision, Volume III: Analytical Report

And, the growth continues… we’re projected to hit 9.3 billion by 2050.

For decades, experts have argued over whether or not our planet can handle this growth. What is not up for debate, though, is the fact that a growing population will affect the demand for goods and services. Food, of course, is high on the list.

The World Bank says, “Between 2005 and 2055 agricultural productivity will have to increase by two-thirds to keep pace with rising population and changing diets.” Okay, this is interesting, but why should we pay attention to this type of information?

As financial advisors, we want to monitor trends that could impact the demand for goods and services, which, in turn, may suggest areas ripe (no pun intended!) for investment. By keeping a finger on the pulse of long-term trends -- like the rising world population -- we might get an early read on investment opportunities that could translate into profits for you.

Getting back to the population/geography question, The Economist says the answer is A) Zanzibar. Does that surprise you?  

Weekly Focus – Think About It

“The investor of today does not profit from yesterday's growth.” --Warren Buffett

Value vs. Growth Investing (10/21/11)

Name	1-Week	YTD	4-Week	13-Week	1-Year	3-Year	5-Year
US Market	1.04	-0.54	6.15	-8.30	7.19	12.43	0.73
Large Cap	1.05	0.55	6.24	-6.87	7.32	10.79	0.16
Large Core	1.77	0.33	6.45	-6.17	7.66	10.33	1.15
Large Growth	-0.95	1.68	4.24	-6.22	8.41	14.77	2.25
Large Value	2.48	-0.80	8.34	-8.46	5.38	7.27	-3.17
Mid Cap	1.19	-2.57	5.50	-11.43	7.08	16.89	2.14
Mid Core	1.87	-1.38	6.74	-10.48	8.54	18.63	2.56
Mid Growth	0.38	-0.72	3.53	-12.30	12.09	18.06	3.79
Mid Value	1.31	-5.72	6.26	-11.53	0.81	13.80	-0.22
Small Cap	0.54	-6.40	7.13	-14.17	5.06	15.88	1.68
Small Core	0.44	-8.13	6.95	-16.37	3.30	15.46	0.47
Small Growth	-0.97	-4.26	5.27	-13.81	9.68	16.11	2.64
Small Value	2.22	-6.70	9.28	-12.05	2.25	15.98	1.63
US Core	1.70	-0.53	6.53	-7.69	7.65	12.42	1.53
US Growth	-0.69	0.92	4.17	-7.99	9.48	15.62	2.67
US Value	2.22	-2.27	7.97	-9.37	4.18	9.17	-2.22

©2004 Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar; (2) is not warranted to be accurate, complete or timely. Morningstar is not responsible for any damages or losses arising from any use of this information and has not granted its consent to be considered or deemed an “expert” under the Securities Act of 1933. Past performance is no guarantee of future results.  Indices are unmanaged and while these indices can be invested in directly, this is neither a recommendation nor an offer to purchase.  This can only be done by prospectus and should be on the recommendation of a licensed professional.

Office Notes:

3.6% COLA for Social Security in 2012

Thank goodness. Now we can breathe a sigh of relief. It looks like the 2.8% COLA projections we have been using with clients may be realistic after all—perhaps even a bit conservative.

After two years of 0% COLAs, inflation adjustments will resume in 2012, with a robust 3.6% benefit increase. Naturally, those who are already receiving Social Security benefits are celebrating the news (until they find out next week how much their Medicare premiums will rise).

COLAs also apply to unclaimed benefits

First, it's important to know that the primary insurance amount (PIA) will be increased by the COLA, whether or not you have started receiving benefits. You do not need to be receiving benefits to take advantage of the COLA increase.

Here's how it works. Prior to age 60, a person's future benefit is affected by increases in the national average wage index. The average wage index determines the indexing factors that will be used to adjust each year's earnings for their average indexed monthly earnings (AIME), and it determines the bend points used to calculate the PIA. Historically, the growth in the average wage index has exceeded the growth in the consumer price index. So younger people's benefits are actually increasing faster than older people's benefits (this is one of the areas being considered for Social Security reform).

Once a person's PIA is officially calculated at age 62, it becomes subject to cost-of-living increases as determined by the CPI-W. To see how this works, let's take a look at our example for Boomer Bob, who we'll say was born in June of 1949 and therefore turned 62 in June of 2011. As a maximum earner from 1971 through 2010, his PIA was calculated in 2011 as follows:

AIME = $7,928

PIA =

0.90 x $749 +

0.32 x $3,768 +

0.15 x $3,411 = $2,391

(Source: SSA Downloadable Detailed Calculator)

In 2012, Boomer Bob's PIA will be increased by the 3.6% cost-of-living adjustment, giving him a new PIA of $2,477 ($2,391 x 1.036 = $2,477).

Benefit will be based on COLA-adjusted PIA

As you already know, Boomer Bob's actual benefit will depend on when he applies. If he had applied as soon as he turned 62, in June of 2011, his benefit would be 75% of his 2011 PIA, or $1,793. Then in 2012, he would get a 3.6% raise to bring his benefit up to $1,858. This is a $65 increase.

But what if, Boomer Bob decides to wait until he is 70 to claim his benefit? Then his benefit will increase by two measures: 1) the gradually decreasing actuarial reduction before full retirement age and the 8% annual delayed credits after full retirement age, and 2) annual COLAs between now and age 70. We know that his PIA will go up by 3.6% next year. Beyond that, we can't know what future COLAs will be, but let's say they're 2.8%. Here will be the effect upon Boomer Bob's benefit:

Starting Benefit Including COLAs and Actuarial Reduction or Delayed Credits
Year	Age	COLA-adjusted PIA	Benefit as % of PIA if he applies this year	Starting benefit
2011	62	$2,391	75.0	$1,793
2012	63	$2,477	80.0	$1,981
2013	64	$2,546	86.7	$2,207
2014	65	$2,618	93.3	$2,442
2015	66	$2,691	100	$2,691
2016	67	$2,766	108	$2,987
2017	68	$2,844	116	$3,299
2018	69	$2,923	124	$3,625
2019	70	$3,005	132	$3,966

As you can see, there's a huge disparity between the $1,793 he'll receive in 2011 if he starts at 62, and the $3,966 he'll receive in 2019 if he starts at 70. So let's even things out a bit by looking at what his benefit will be in 2019, when he is 70, depending on when he started benefits. Again, we are assuming a 3.6% COLA in 2012 and 2.8% COLAs thereafter.

Benefit at Age 70 Based on Claiming Age
Year	Age	Age benefit started	COLA-adjusted benefit
2019	70	62	$2,254
2019	70	63	$2,403
2019	70	64	$2,605
2019	70	65	$2,804
2019	70	66	$3,005
2019	70	67	$3,245
2019	70	68	$3,486
2019	70	69	$3,727
2019	70	70	$3,966

So his income at age 70 will be substantially lower if he applies at 62 than if he applies at 70.

One of the points we like to make when encouraging clients to delay benefits is that COLAs magnify the disparity between early and late claiming. So let's see what Boomer Bob's COLA raise would be when he turns 71 depending on when he started benefits. Again, we'll assume 2.8%

Benefit Raise at Age 71 if COLA is 2.8%
Age benefit started	COLA-adjusted benefit at age 70	Monthly raise at age 71 if COLA is 2.8%	Annual raise at age 71 if COLA is 2.8%
62	$2,254	$63	$756
63	$2,403	$67	$804
64	$2,605	$73	$876
65	$2,804	$78	$936
66	$3,005	$84	$1,008
67	$3,245	$91	$1,092
68	$3,486	$98	$1,176
69	$3,727	$104	$1,248
70	$3,966	$111	$1,332

Note how much bigger the raises are on the higher benefit amounts. We can assume that all Social Security recipients are celebrating the 3.6% COLA increase announced yesterday. But some recipients are probably celebrating more than others. These would be the ones who received higher raises because the 3.6% increase was applied to a higher benefit amount.

In today's low interest rate, low return environment, the fixed Social Security formula that escalates the starting benefit for delayed claiming is looking like a better deal all the time. And when COLAs are applied to the higher amounts, annual raises become significant as well.

After two years of 0% COLAs, many people have forgotten how valuable these inflation adjustments can be. This is where our Social Security calculators come into play. We can show clients and prospective clients how much more they stand to receive over their lifetime if they delay the start of their Social Security benefits, thanks to both delayed credits and COLAs.

By the way, automatic COLAs started in 1975 and have averaged 4.2%. Removing the double-digit COLAs of 1980 and 1981, the COLA has still averaged 3.7%. In light of this, I think our 2.8% COLA projections are reasonable.

Other COLA-related changes

• The maximum taxable wage base rises to $110,100 in 2012, up from 106,800 in 2011.
• The earnings test before full retirement age rises to $14,640 in 2012, up from $14,160 in 2011.
• The earnings test in the year a person reaches full retirement age rises to $38,880, up from $37,680.
• The maximum Social Security benefit for a maximum earner retiring in 2012 will be $2,513, up from
  $2,366 in 2011.

As always, any questions can be addressed to the office.

Best regards,     

Michael L. Schwartz, RFC®, CWS®, CFS

P.S.  Please feel free to forward this commentary to family, friends, or colleagues.  If you would like us to add them to the list, please reply to this email with their email address and we will ask for their permission to be added. 

Securities and advisory services offered through First Allied Securities, Inc., Member FINRA/SIPC

Schwartz Financial Service, Inc is not an affiliate of First Allied Securities, Inc.

This information is provided for informational purposes only and is not a solicitation or recommendation that any particular investor should purchase or sell any security. The information contained herein is obtained from sources believed to be reliable but its accuracy or completeness is not guaranteed.  Any opinions expressed herein are subject to change without notice.  An Index is a composite of securities that provides a performance benchmark.  Returns are presented for illustrative purposes only and are not intended to project the performance of any specific investment.  Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly.  Past performance is not a guarantee of future results.

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* The DJ Global ex US is an unmanaged group of non-U.S. securities designed to reflect the performance of the global equity securities that have readily available prices. 

* The 10-year Treasury Note represents debt owed by the United States Treasury to the public. Since the U.S. Government is seen as a risk-free borrower, investors use the 10-year Treasury Note as a benchmark for the long-term bond market.

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