I am not an accountant but I do like to track my financial situation.
I want to know my “net worth”. Not sure what that is or why I should want to know, but I am curious.
According to some simple definitions, net worth is your assets minus your liabilities.
Is that all? If so, what are assets and liabilities?
Finally, to my actual question:
I am retired and am collecting social security (I live in the US).
Is that an asset? Can I figure out how much I will collect in the future and call all of that part of my net worth? If not, why not?
I have an annuity. It has a cash value and a higher total value over my entire lifetime. Should I count the total value or the (ever decreasing) cash value? Once the cash value hits zero, is it no longer an asset? It still pays me money, so it seems like it should be.
In general, how does one account for income streams in a net worth calculation?
I count social security as an asset. I take the cost of a single payment immediate annuity that would pay the same amount as my social security and I count that as an asset.
For example, I go to this calculator and input the data and find out that an annuity with the same payout as my social security would cost $310,000. I call that an asset and add it in with my bond allotment, as it has the same safety as a government bond.
I’m not collecting social security yet, but the fact that I could start anytime is an asset.
I completed a first year accounting course, so treat with caution.
An asset is generally something that generates income in some manner. This could be a truck that a company uses to transport stuff; without that ability, the company produces less income, or even no income. A bank account is an asset, unless you’re a bank, ironically. I presume it’s an asset because the money is used to pay staff, buy other assets, etc. Office supplies are assets. Inventory you hope to sell are assets. Accounts receivables (money owed to you that has not been paid yet) are assets. Land and buildings that your business owns are assets. Even brand names can be considered assets.
Liabilities are obligations, usually debts. However, this could also be labor (as in someone paid you ahead of time to do something, so now you owe them a certain value of labor). Sometimes liabilities are directly paired with assets; your house is an asset, and the mortgage you need to pay on it is a liability. You could have a $600,000 house with a $400,000 mortgage left on it. Record the $600,000 as an asset and $400,000 as a liability.
Needless to say, these definitions that I’ve been taught apply more to businesses than individuals.
The basic equation is Assets = Liabilities + Equity, or Equity = Assets - Liabilities.
(Bank accounts are liabilities to the bank because they owe customers that money. At any time a customer can ask for the money back. Meanwhile the bank considers a loan an asset (money loaned to a customer) because the customer is expected to pay that money back with interest. That interest becomes revenue for the bank. Since the bank probably borrowed that money that they loaned out, they are probably paying interest on that, so the bank is mainly interested in the net interest revenue.)
Social security is an asset; it’s a pool of money that has been invested and generates income for you (or it’s money taken from current taxpaying workers that is hopefully being invested). However, much like calculating the value of a pension, it’s very complicated to determine the value of your social security. You would probably need to pay someone to determine that.
Following the general guidelines that I had been taught, I would use the payments you made over the years, without adjusting for inflation (maybe they don’t teach that in first year) but including any matching payments made by employers. However I couldn’t figure out how to reduce the value of your social security as you receive payments (if you are even supposed to do that); while it’s creating “revenue” for you, calculating the expenses and making adjustments using actuarial values are beyond the abilities of a novice. (You use actuarial values because it’s a payment for life based on the “average” or “median” expected lifespan.)
Edit: Or just use that calculator posted above in the thread.
Note that this “accurate” calculation is almost valueless. Your payouts aren’t just based on your contributions, but inflation, the economy, politics, etc. Generally people care about the income from social security, rather than an estimated value. However you could get it done anyway, as it’s an interesting exercise.
Same for social security. Once you get the money, record that under “Cash” on your balance sheet.
If a company you own stock in went bankrupt tomorrow it wouldn’t be worth anything either, but we don’t count its value as zero today.
Social Security (or public pensions in other countries) isn’t generally counted when people speak of ‘net worth’ I think for two reasons
in an given country a large majority of people will have a claim on the public pension system (albeit not exactly the same amount) so it’s kind of an understood baseline
it requires calculation to convert the income stream to a present value.
As you suggest, this PV calculation must take into account the probability of being alive in a given future year. You can fairly easily* derive that probability from the standard mortality table used by the SS Admin. However a given person (or couple’s) life expectancy might vary from that table significantly due to life style, current health etc. It’s not so easy to access a full table of year to year probabilities for an alternative situation. Then, though somewhat less importantly, you have to determine an appropriate discount rate.
However for a lot of people SS and pensions are a big part of their retirement, so it probably makes more sense to express the present value of assets like stocks or bonds as an expected future stream of income than it does to express the future stream of income represented by SS as a present value. But you have to have some apples to apples aggregation of everything to know where you stand overall.
*for people familiar with basic statistics and spreadsheet manipulation, and there are internet calculators though their accuracy might vary.
In principle, social security payments are an annuity, and annuities are bought and sold - there is an up-front cash value that’s equivalent to the sum of the future cash flows. The uncertainty about the number of payments is just an actuarially assessed risk, and it could in principle be offset with life insurance.
In fact, I just executed just such a transaction for a company pension. This was a “defined benefit” pension, so analogous to social security. I exchanged the future payments for a single up-front cash amount today. But there are restrictions on this - I am only allowed to place the money into a recognized pension structure, where I will manage the assets myself.
There are obvious reasons why doing such things should be carefully regulated. You don’t want people entering into contracts to receive cash up-front in return for giving away their future social security payments or pensions, then spending the money on hookers and blow. You can set its replacement value as that of an equivalent annuity, even if you can’t actually sell the cash flows; and you can call it an asset, just not a liquid asset.
I think Riemann explains my issue the best. One reason I specified my interest in individual net worth is to try to focus on the issues of a single person not a company.
I am interested in knowing how much wealth I have, as all things financial, that to me is harder than it sounds. Especially since I wish to compare that value to statistics about the country as a whole. So I need to know how others treat various sources of income so that I can compare my estimates to others.
Social Security is a puzzle in this regard. It has no value after I die, but then after I die I don’t care. It’s value is entirely dependent on my life expecancy. Neither factor enters into the problem for a company. But it seems to me it is an asset, for many retirees one of their most valuable assets. OTOH, you can’t sell it, so I guess that means it has no cash value. Riemann’s concept of liquid vs illiquid assets seems to handle this. But which ones factor into what most people call net worth?
I am certain this is all explained somewhere, I just can’t find an explanation I can understand.
Bzzzt. An asset, from an accounting standpoint, is something that has economic value. An asset can be used to generate income, and that’s most often the reason a business acquires an asset, but for a private individual very few assets generate income. You might use you car to go to work, but your golf clubs are an asset but they don’t generate income.
If you want to compare your net worth to statistical data about net worth, do not include SS payments, or pensions, or any other payments you will receive in the future unless it’s deferred income (fancy pants executives sometimes make arrangements like this) or somebody is paying you back for a loan.
IANAA but I do know a few things from graduate accounting. With SS there are two issues: indefinite amount, and future income. You can determine the net present value of a series of definite future payments, but you can’t do this with SS because you won’t know the amount until you’re dead. Also, you can only count future income as an asset if it’s a receivable, which means you’ve already earned it and you are going to get paid later.
What I don’t know is how accountants treat SS payments–I would think it’s not considered earned until the moment you get the check. Even though you might say you contributed to SS for years when you were working so you “earned” it, that’s not an accounting definition of earning income.
Riemann makes a very good point about annuities but AFAIK this does not apply to SS and I have never heard of anyone who will buy your future SS payments. If they would, then I suppose it would be legitimate to use the offered amount as valuation of an asset.
Of course it has a value. The value is the cost to replace it in the current market and that can be done with a single payment immediate annuity. If you have a spouse you need to choose one with a joint life, since your spouse is eligible for one from social security.
No, it’s your comeback that’s off your own original point. Which seemed to be that SS didn’t have a value because of uncertainty about the future, in this case how long the recipient will live. To which my analogy was not false. A company’s future profits, and even future existence, is also uncertain.
Now you’ve changed your point to focusing on the illiquidity of the Social Security asset. But as others have pointed out this is also wrong. Just because something is illiquid (can’t readily sell it) doesn’t mean it has no value. We could all get fabulously wealthy buying for some nominal amount each of the world’s assets which are highly illiquid if the owners were really unwise enough to consider them valueless because illiquid and consider any small payment for them a windfall.
Anyway back to your original wrong point, the one I answered, it’s obvious that you can value a stream of ‘infinite’ payments that end when somebody dies. Insurance companies do that all day long. You can easily look up right now how much they need you to pay them now to give you a stream of (even inflation adjusted like SS) payments the rest of your life based on your current age. I just wanted to give an example that might provoke a little broader thought on your apparent concept that uncertainty of future payments means they have no value.
thanks for all the replies!
So far, as I understand the discussion, SS is an asset and is calculated by figuring out the value of an equivalent single-payment annuity. That does not take into account the inflation adjustments that will apply to SS, but it is a first order approximation.
However, it is not clear whether I should count SS at all in an net worth calculation when I wish to compare to national statistical measures.
As noted just above there is a market, albeit more limited, for inflation adjusted annuities. These are still an approximation of the value of SS because basically* SS is US federal govt risk rather than slightly higher major insurance company risk. IOW the future payments should be discounted at something like the federal govt’s borrowing rate rate rather than an insurance company’s borrowing rate.
*Congress can change the Social Security program any time to give particular people more or less. At some point to some extent, it probably will. But there tends to be a very strong political constraint on reducing payments for people already receiving it or about to. It’s just not the same cut and dried situation of a US govt bond either paying off as promised or not. Although Congress could in some future govt financial crisis decide to maintain SS payments as promised and give bondholder’s back less than 100% on the dollar. Not saying either thing is going to happen, just that SS and US govt bonds aren’t exactly the same credit risk, not clear which small risk is smaller.
I wouldn’t count it in for statistical purposes, I only use it for determining asset allocation. It keeps me from being too bond heavy. Although now in retirement I’ve gone to asset allocation based on what I need rather than a fixed percentage, so my asset allocation floats and is really only of academic interest.
The company’s future profits are the only reason the stock has any value. If there were to be no future profits, the stock is worth zero. The stock value is the market’s estimate of the discounted value of future profits. An annuity’s value is the insurance company’s estimate of the discounted expected payouts to the average annuitant. Social Security’s value is likewise the estimate of discounted expected payouts to the recipient. The second two have more in common as a calculation technically, but all three are fundamentally the same. In general assets’ value derives from the discounted value of future uncertain payments, with a few exceptional types of assets that don’t fit that description.
SS: Not an asset. You can’t sell it, transfer it, etc.
Annuity: (Usually) an asset. You can often sell annuities to companies for a lump sum. That lump sum is the value of the asset.
Not the same as the cost of getting a similar annuity now. It’s not the value of an asset to you that matters. It’s the value of an asset to others that matters. E.g., the value of a diamond ring is not what it would cost you to buy a replacement, it’s what you’d get by selling it.