Abstract
We develop techniques to estimate the present day value of the future social security benefits of a retiree based upon their chosen date of retirement, the term structure of interest rates, and life expectancy forecasts. These valuation methods are then used to determine the optimal retirement time of a beneficiary given a specific wage history and health profile in the sense of maximizing the present day value of future cashflows. We then examine how a number of risk factors including interest rates, disease diagnosis, and population life table risks impact the current value of future payments. Specifically, we utilize principal component analysis in order to assess interest rate and population life expectancy variation risks. We then examine how such risks range over distinct income and demographic groups and finally summarize future research directions.
Highlights
Introduction and OverviewLabor force participants typically rely on accumulated wealth during their working years to finance retirement through voluntary or mandatory means
We focus on optimizing the present value of future Social Security benefits, we note that circumstances may arise where a beneficiary may have a different financial goal in mind
We presented a collection of techniques for the valuation and risk assessment of the present value of future Social Security benefits that incorporate the retirement age and health profile of the beneficiary, life table forecasting models, and the SSA’s monthly benefit specifications
Summary
Labor force participants typically rely on accumulated wealth during their working years to finance retirement through voluntary or mandatory means. We develop a PCA based model to understand the impact of interest rate risk on benefit value and develop a health risk modeling framework to enable a retiree to gauge the change in present value of future Social Security cash flows after contracting a disease We note that this is distinct from stochastic process based yield curve models (cf (Brigo and Mercurio 2007) for a review) and hope to compare these in subsequent work. We provide a number of new numerical studies that examine how Social Security present value and optimal retirement age vary by cohort, income level, and health profile of the beneficiary.
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