Making Sense of Social Security

With the current deficit, the conversation on social security has become binary. You probably hear comments such as, “Social Security is going away,” or “you can’t count on social security.” These comments are warranted given our difficulty managing national debt but, to effectively plan for retirement, you need to account for some level of social security.

A few things to keep in mind as you incorporate Social Security in your retirement planning:

Age matters (a lot): Your quarterly green statement (hopefully you’ve seen one of these) will give you the expected monthly payout based on when you claim social security. As you will notice, the payout is less if you claim it sooner (at 62) and gradually increases if you wait until later (up to 70). For example, a client’s social security statement gave the following payouts:

• At 62  –  $798/month
• At 67  – $1,177/month
• At 70  – $1,699/month

So, if my client waits until 70, the monthly payment will be significantly larger but the tradeoff is not receiving any payments between 62 and 70. Depending on your financial situation, deferring payments may not be an option. If, however, you have a choice, waiting as long as possible to collect is the smart financial decision.

It’s inflation adjusted: The payouts above are in ‘today’s dollars’ – meaning you can compare them to your expenses today. Each year, the government will increase the payout by inflation so you don’t lose purchasing power (in 2012, the increase is 3.6%). By seeing these figures in today’s dollars, it’s much easier to understand how social security would supplement your expected retirement lifestyle.

It can be taxed: Up to 85% of social security can be taxed depending on how much you make. As always, there is a formula to calculate taxes on social security but, in general, the more you make, the more social security will be taxed.

It has a ceiling: Social security has a max, both on how much you contribute (you’re only taxed on the first $142,800 of income in 2021) and how much you can receive (the maximum benefit is $3,113/month at full retirement age in 2021). So, no matter how much you make during your working years, your max retirement benefit at full retirement age (65-67 depending on when you were born) is $3,113/month (it’s more if you wait until 70).

It’s reduced if you earn: Thinking about working during retirement? If so, keep in mind that your social security benefits get reduced depending on how much you earn. In 2012, at full retirement age (65-67), your social security benefit will be reduced $1 for every $3 of earning above $38,880. Don’t worry, you get it back after you stop working but it’s important to know you can’t fully ‘double dip’ with working and social security.

It’s all about spending: Understanding the payout ceiling above is critical as you plan for retirement. If your spending is relatively low, social security may cover a large portion of your retirement lifestyle and reduces the amount you need to personally save. On the other hand, if you have a more expensive lifestyle, social security will only supplement a small percentage, increasing the importance of having other savings (e.g., 401(k), IRA, etc.). Let’s take a look at an example.

• Mary (age 66), a school teacher, expects to spend $3,000/month during retirement. Her social security payout at 67 is $1,500/month, covering 50% of her expenses
• Jane (age 66), a consultant, expects to spend $8,000/month during retirement. Jane qualifies for the max payout (since she contributed more) of $2,513 but it only accounts for 31% of her expenses.

As you can see, Jane’s higher income yields a higher social security payout; however, it accounts for much less of her retirement expenses and puts the onus on her to save.

All in all, despite the constant drubbing of social security (which is warranted), it’s important to consider it as part of your retirement planning. I’ve worked with numerous clients whose projected social security and pension is enough to cover over 80% of their retirement expenses, reducing the amount they need to save. On the flip side, the more you earn (and spend), the more you will depend on your own savings (e.g., 401(k), IRA, etc.) to supplement social security.

What are your thoughts on the future of social security? How do you incorporate social security in your retirement planning?