Lifetime Benefits and Taxes in Social Security: The Effect of Different Discount Rates on Present Value Calculations

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Document date: February 18, 2011
Released online: February 22, 2011

Abstract

It is often useful to compute contributions and benefits over a lifetime when studying policies for retirement and Social Security. However, these calculations are complicated by factors like economic growth and inflation, which change the relative value of investments over time. The fact that \$1 in the bank today might accrue enough interest to be worth \$1.03 next year leads economists, accountants, and actuaries to find ways to equate the two amounts at a point in time. This fact sheet explains how the discount rate affects present value calculations.

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Introduction

It is often useful to compute contributions and benefits over a lifetime when studying policies for retirement and Social Security. However, these calculations are complicated by factors like economic growth and inflation, which change the relative value of investments over time. The fact that \$1 in the bank today might accrue enough interest to be worth \$1.03 next year leads economists, accountants, and actuaries to find ways to equate the two amounts at a point in time. That is, they try to find the value of an account today that might provide the stream of benefits to be paid out tomorrow, assuming some interest would be paid on the account. A similar calculation can be made on how much a worker paid in taxes or contributions over a lifetime, depending upon the interest earned on those contributions.

We can do the same for taxes. If one adds up the taxes the worker pays, excluding any interest that might have been earned on those contributions, the total tax burden adds up to almost \$192,000. At a 2 percent or 3 percent real return, those contributions would have grown to approximately \$291,000 and \$364,000, respectively, by 2010.

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Topics/Tags: | Employment | Retirement and Older Americans

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