We use the inflation rate and the nominal rate of return to determine the real rate of return, which we use as the discount rate to calculate the present value of your lifetime Social Security benefits.
We base our default nominal rate of return on the 30-year nominal Treasury bond yield. To determine default long-term inflation expectations we subtract the 30-year Treasury Inflation-Protected Securities (TIPS) yield from the Treasury bond yield. We adjust these values if needed in early January and July of each year based on average daily yields on 30-year nominal Treasury bonds as well as 30-year TIPS in the prior months of December and June, respectively.
To learn more about how we determine safe inflation and return rates, see Inflation and Rate of Return Data (includes spreadsheet data).
The only way people can move real purchasing power from the present to future years in which they may be alive is by using TIPS. This means that receiving, say, $10,000 (measured in today's dollars) of Social Security benefits in, say, 30 years has a value today equal to what it would cost today to buy a bond paying off $10,000 of real purchasing power in 30 years. If the real return on TIPS is zero, $10,000 (measured in today's dollars) arriving in 30 years is equal to $10,000 today. If the real return is positive, $10,000 coming in 30 years would be less, potentially far less, than $10,000. Whatever the prevailing real return is, this rate is used to figure out what future Social Security benefits are worth today because it tells us how to convert money today into safe money tomorrow, which is what Social Security is giving us.
By replacing our default rate of return and inflation rate with other values, you can alter the real return at which our software discounts (values) your future Social Security benefits. But be careful. Social Security, like TIPS, is a safe asset. Valuing it like a risky asset such as stocks, by entering, say, a much higher rate of return will lead you to inappropriately undervalue future Social Security benefits. Social Security benefits are not risky. Stocks are risky. In fact you could lose a major portion of your investment in stocks, e.g. the 49% market decline in 2000 or the 53% decline in 2007. It wasn’t until Oct 2016 that the market recovered from the 2000 decline as measured by the S&P 500. This is why stocks yield, on average, a much higher real return than TIPS. Direct comparisons of economic alternatives can only properly be made for equally risky alternatives. Hence, valuing Social Security benefits based on the average real return of risky assets is an improper comparison. We strongly recommend you use our default rate of return and inflation assumptions since they are what the market is saying future Social Security benefits are worth. Only change these if you have very good economic rationale and you fully understand the implications.