For generations, American retirees have relied on their Social Security benefits as a major source of retirement income security. But will these benefits still be around when you retire? And if so, what is the correct way to factor them into your retirement planning? These are some of the questions we will explore in this article.
We have all heard that our Social Security system is expected to run into serious financial difficulties in the not-so-distant future due to our aging population. The 2021 OASDI Trustees Report projects that by the start of 2034 benefit payments to retirees will exceed the Social Security tax revenues. However, the Social Security tax revenue will still be sufficient to pay 75% of benefits at that point and the Social Security Administration (SSA) has identified and priced literally hundreds of benefit and tax changes that can keep the system solvent.
At the one extreme, the problem can be solved by incleasing the Social Security tax from 12.4% (6.2% paid by both employer and employee) to about 15.8% (7.9% paid by both employer and employee), starting in 2021. Other options include increasing the full retirement age, changing the basis for determining the cost-of-living increases, raising the taxable wage base or applying an extra tax on very high incomes.
The ultimate solution will probably include some combination of these options. It is unlikely to include an outright decrease in the benefit formula itself, although you may need to wait longer to get an unreduced benefit if the full retirement age is increased.
If your Social Security benefits are not going anywhere, what is the right way to include them in your retirement planning? Getting accurate Social Security estimates is not difficult. Using the right numbers in your retirement planning is where things get tricky.
The SSA offers a set of highly accurate and free calculators. They take into account all the details that go into your actual benefit calculation. The main difference between them is how they handle your earnings history:
Quick Calculator estimates your past earnings based on your current salary, with an option to overwrite the historical pay used.
Online Calculator lets you enter your earnings history manually (from your Social Security statement).
My Social Security Retirement Calculator pulls out your actual earnings history automatically but requires online registration and a rigorous verification process.
All of these calculators deliver the most robust and reliable estimates of your benefit - provided you supply your correct earnings history.
The SSA calculators produce two sets of results - measured in current dollars and future dollars. Picking the right set for your retirement planning purposes is where many people and, unfortunately, many retirement calculators, get confused. And the choice makes no small difference - the future dollars estimate can easily be twice as large as the current dollars value!
The current-dollar estimate helps you understand the value of your future benefit
Your current dollars results illustrate how much your Social Security benefits are worth in today's dollars or how much you would receive if both your salary and the national wage index remain fixed forever. Therefore, unless you are within a couple years of retirement, this number is far below the actual dollar amount you can reasonably expect to receive.
Put simply, if your current dollar Social Security benefit estimate is $20,000, it means that your actual benefit at the time you retire will be enough to afford what $20,000 can afford today.
If you were given the actual amount you can be expected to receive (the future dollars estimate), you would have no way of knowing how much that number is worth and what it could buy at the time you retire. However, while the current-value estimate seems like a great number to have for your own understanding, it is NOT the number to use for retirement planning.
Accurate retirement planning using future dollars
Your retirement planning is only as accurate as the projections it makes of all the pieces of your financial reality. Each piece has its own reasonable growth rate. For example, each of the following should be increased as suggested:
- Your savings with a reasonable investment return
- Your personal expenses with a reasonable consumer price inflation
- Your salary with a reasonable earning growth rate
- Your fixed-rate mortgage payments should be kept flat (and then reduced to zero when paid off)
- Your healthcare costs should be projected with a reasonable healthcare price and age inflation
- Your home value and property taxes with an appropriate real estate inflation for your area
Your Social Security benefit should also reflect a best estimate projection of each of its building blocks - exactly what the future dollars estimate from the SSA calculators does.
We cannot simply assume that the individual growth rates average out to a perfectly uniform and simple number. We all have a unique basket of the items listed above, and that basket changes over time. A robust and reliable retirement planning tool should use future dollars projections for each major component, including your Social Security benefits, based on well-researched assumptions.
Unfortunately, almost all current retirement calculators either ignore inflation altogether or apply a flat inflation assumption to everything.
Ignoring inflation altogether is a common problem with many retirement planning tools, including some sophisticated tools used by large banks for paying customers. Such calculators only project your savings forward with investment return but ignore how your living expenses, medical costs, and housing expenses will change over time.
Keep in mind that the vast majority of retirement calculators are created by investment experts and focus on investment analysis. They help you understand how much you can expect to earn on your retirement savings based on your risk tolerance (and assuming you use their investment products and services). Since setting a reasonable investment return assumption is one of the most important aspects of retirement planning, many of these calculators can be very helpful.
However, if they ignore inflation altogether, you are probably better off using them for just that - for investment analysis. When it comes to your overall retirement planning (for example, when deciding how much you need to save and when you can retire), you need a more reliable tool that reflects inflation.
Even a simplified adjustment for inflation is far better than keeping everything in current prices. Combined with a future dollars estimate from an SSA calculator, you can get a quick ballpark estimate of your retirement planning results. However, you should be aware that this calculation is still seriously flawed. Not every part of your financial reality can be expected to increase at identical rates. In fact, the SSA's calculator uses different growth assumptions for every component of the Social Security benefit calculation - and so should your retirement calculator.
The future dollars estimate you receive from the SSA calculators tells you how much you will receive in Social Security benefits the day you retire. This number will further grow every year after you retire to keep up with cost-of-living increases. Since these increases are not included in the number from the SSA calculators, your retirement calculator needs to apply them for you.
If your retirement calculator uses the same inflation rate for everything, make sure it applies that rate to your Social Security payments as well. The best approach is to use the SSA's own assumption for future cost-of-living adjustments.
Not really, unless you are just about to retire. Your Social Security statement uses a current dollars approach, which means that it assumes that neither your earnings nor the average wage index will increase past the statement date. Thus, unless you are within a couple years from retirement, your Social Security statement is likely to grossly understate your projected benefit at retirement.
However, there is one piece of valuable information you can get from your statement: your Social Security earnings history. These are the numbers you can plug into the SSA's Quick Calculator or Online Calculator to get an accurate projection of your Social Security benefit.
Uncertainty doesn't mean we should not and cannot make reasonable forecasts about the future based on the best available data and models. The correct way to manage uncertainty is to make reasonable, well-researched assumptions and then update your calculations on a regular basis to reflect actual data. This approach allows you to make timely adjustments to your plan along the way.
This process is not perfect, but it is good enough for insurance companies and retirement systems to manage uncertainty. It will likely work well for you, too. In fact, while these organizations are often required to fund any short-term shocks immediately, you have the luxury of spreading their impact over the rest of your life!
Unfortunately, many retirement calculators don't allow you to enter your spouse's Social Security benefit separately from your own. You are forced to add your and your spouse's benefits and enter them in the single slot provided.
That should work, right?
Not exactly. Even though you can get a good future dollars estimate from the SSA calculators for you and your spouse separately, simply adding them together assumes you will retire at the same time and commence your Social Security benefits at the same time. This is rarely the case. Even if you retire at the same time, you may choose to start receiving benefits at different times. For example, many people wait until age 70 to start cashing in on their benefits. In that case, even a one-year age difference means your calculations will be off by an entire year of Social Security income.
Adding your Social Security benefits together also assumes that your spouse will live for exactly as long as you. In reality, one of you will likely die before the other, and the survivor will get a survivor benefit on top of their own benefits.
And while on the topic of spouses, do consider the "spousal benefit" that your spouse may receive on your account (it will be listed in your results from the SSA calculators). This is the benefit your spouse can be paid if higher than their own earned benefit. This is particularly important for couples where one spouse has a limited earnings history.
We know this article sets a very high bar for retirement calculators. As actuaries who work on long-term financial projections for insurance companies and retirement systems (such as Social Security), we would not even be allowed to publish a projection that did not follow all of these principles, and possibly many more.
Considering the imperfect world in which we live, you may consider using a calculator that applies inflation (even if using a single rate for everything) and then enter the future dollars estimate from any of the SSA's calculators. This should get at least the Social Security part of the model working reasonably well.
If you are looking for a reliable and free option, you may also consider our free retirement calculator, MoneyBee. It implements all the principles discussed in this article. It estimates your future dollars Social Security benefit automatically for each retirement age scenario, separately for you and your spouse, exactly matching the SSA calculators. It also uses an appropriate growth rate for each major component of your financial reality.