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June 01, 2021 at 10:21 AM
What You Need to Know
- The balance sheet is an important way to communicate an investor’s net worth, but income streams like Social Security are often left out.
- Guaranteed income can affect portfolio risk levels and guide withdrawal rates.
- Here's a look at how advisors can estimate the value of guaranteed income streams.
Retirement is the largest purchase most people will ever make. Fortunately, a good chunk of that expense is covered from a variety of guaranteed income sources, such as Social Security retirement benefits.
Despite the importance of guaranteed income, though, in my experience most advisors view guaranteed income only as an income source and do not attempt to estimate its value to share with clients.
That’s a mistake.
While guaranteed income may not be an asset in a more traditional sense, like a 401(k) or IRA, it definitely has an economic value that should affect decisions around things like the appropriate portfolio risk levels and safe withdrawal rates.
While you may think the idea of estimating the value of guaranteed income is nuts, 67% of respondents in an incredibly unscientific poll I ran on LinkedIn thought that guaranteed income should be included as an asset on the balance sheet for retirees.
Therefore, if you’re already providing information about the estimated value of guaranteed income to clients, bravo! If not, hopefully this article can help change your mind!
Building a Better Balance Sheet
The balance sheet is an important way to communicate an investor’s net worth. A traditional balance sheet typically focuses on assets and liabilities that are relatively easy to value, such financial accounts, like a 401(k)s or IRAs, the home, etc.
Many assets that are included on the balance sheet typically are assumed to be income sources during retirement, especially financial accounts. For example, it is common to assume a retiree will draw down an IRA to fund spending in retirement. From this perspective financial assets are implicitly assumed to be both an asset on the balance sheet and income source during retirement.
While it is common to include guaranteed income as an income source during retirement (in a financial plan), the estimated value of guaranteed income is not typically included on a balance sheet, or even communicated to clients, based on my experience communicating this concept to advisors.
While I acknowledge that guaranteed income is not a traditional asset, it is possible to estimate the value of the benefits and how this value can affect a variety of retiree decisions. I’ll discuss three.
1. It can help clients better understand their true net worth.
Sure, guaranteed income isn’t as liquid as an IRA, but a retiree household with $50,000 in guaranteed income is a lot wealthier than one with $10,000 in guaranteed income, ceteris paribus.
2. It should affect portfolio risk levels.
Guaranteed income is a relatively safe, bond-like asset. For example, Social Security retirement benefits are effectively an inflation-linked government bond. This means retirees may need a lower allocation to government bonds than traditional asset allocation models would suggest.
Additionally, overall risk levels for retirees can be higher among retirees with more guaranteed income given the bond-like nature of the asset, especially with respect to funding retiree consumption.
