Why Calculators Should Use Inflated Social Security Benefits
Most retirement calculators use "current dollar" Social Security benefits. Here’s why "future dollar" estimates are the right numbers for retirement planning.
If a retirement calculator projects your savings with an investment return, it should also project all other financial aspects with a reasonable growth rate for consistency. Otherwise, you will have a distorted, internally inconsistent model. Your Social Security benefits should also be projected forward and this needs to be done thoughtfully, where each component of the benefit calculation is projected separately with reasonable assumptions.
What are "current dollar" and "future dollar" estimates?
Your Social Security benefit is calculated as a percent of your average earnings over your best 35 years. Your earnings are increased with the Average Wage Index (AWI) between the year you earned them and the year you turn 60. Current dollar estimates (as those from your Social Security statement) assume that neither your pay nor the AWI will increase in the future. Their main purpose is to give you a sense of what your benefit may be worth in current prices. However, when these estimates are plugged into a retirement planning model where everything else is projected forward, you end up with an internally inconsistent model.
Future dollar estimates increase both your pay (using a rate specified by you) and the AWI (using the "intermediate" assumptions from the latest Social Security Trustees report). They also increase your projected benefit with cost-of-living adjustments (COLAs) from age 62 to the benefit commencement age (up to 8 years of increases), the way it is done in real life. This means that current dollar estimates may be fine if you are very close to commencing your benefit payments, but the gap between the two estimates grows quickly the further away you are.
How different are the benefit values under the two methods?
Again, the magnitude of the difference will depend on your current age. Let's take a look at four sample individuals aged 30, 40, 50 and 60, respectively. Let's assume that each of them has a current income of $50,000 that has grown by 2% per year in the past and will continue to grow at that rate in the future. Let's also assume that each person retires at age 65 and commences their Social Security benefit at age 70. Here are their estimated annual Social Security benefits at age 70 under the two methods:
| Current Age | Current dollar method | Future dollar method |
| 30 | 50,820 | 103,416 |
| 40 | 42,948 | 80,628 |
| 50 | 38,904 | 63,096 |
| 60 | 38,232 | 48,444 |
Obviously, there's a big difference in how we plan for retirement if our Social Security benefit is $50,000 higher or lower. Keep in mind that this difference can be twice as big if you are married (for simplicity, we assume our four sample individuals are single). We will simply need to save a whole lot more if using a current dollar Social Security benefit in an otherwise inflated model.
For example, suppose our four sample individuals have current savings of $50,000, $100,000, $170,000 and $280,000, respectively, and each plans to retire at 65 with a monthly personal budget (after taxes and required expenses) of $2,000, increased with inflation in each future year. For the current dollar method, we will use the above benefit estimates at age 70, but we will increase them with COLAs thereafter. If we were to keep those initial benefit values unchanged throughout retirement, the current dollar results below would get even more out of whack. Here's what percent of pay our four sample individuals will have to save to achieve this goal:
| Current Age | Current dollar method | Future dollar method |
| 30 | 45% | 5% |
| 40 | 54% | 6% |
| 50 | 65% | 5% |
| 60 | 84% | 5% |
The required savings rates under the current dollar method is prohibitively high because everything else in this model is inflated, except for their initial Social Security benefit. Things get worse in the older scenarios. Even though the dollar difference between the two methods is smaller at older ages, older folks also have fewer years to make up for the dramatically lower benefit estimates.
What if nothing is inflated?
Using a current dollar approach for everything won't fix the problem. It will just distort it even further. Not everything is expected to grow at the same rate, so we can't simply take the current values of everything. Your investments are likely to grow faster than general inflation. Your health care costs are likely to grow even faster as you age. Your mortgage payments will most likely not grow at all and then disappear altogether.
What's wrong with being conservative?
Making conservative assumptions is always a good thing, as long as we stay within a reasonable range. For example, if your investment advisor tells you that there's a 90% chance your investments will average between 4% and 8% per year, a conservative assumption will be 5% or 4%. An assumption of 0% may be conservative but it is not reasonable. Prudence is always a good thing as long as it stays rooted in reality.
If you are invested in an S&P 500 index fund, few registered investment advisors will recommend that you use 0% average annual future return over the next 30 years in your retirement planning. It is not a reasonable assumption. Same is true about assuming 0% growth in the Average Wage Index when estimating your future Social Security benefit.
Isn't Social Security going bust anyway?
We discuss the looming financial difficulties for our Social Security system in the following article, which we update after each annual Social Security Trustees Report. The bottom line is that none of the solutions being discussed involves using frozen wages when calculating your benefit, as is done under the current dollar method. In fact, even changing how the COLAs are calculated has turned into a thorny issue. The ultimate solution will most likely involve a combination of higher Social Security taxes and perhaps further increases to the full retirement age. An outright decrease in benefits seems unthinkable politically.
Conclusion
Unless you are within a couple of years of starting your Social Security benefits, there is really no way to go around using future dollar Social Security estimates in your retirement planning. Then, provided that all other financial aspects are also thoughtfully projected forward, you can have an internally consistent model. And, yes, the peace of mind that you have done your retirement planning as prudently and diligently as possible.