How to factor in Social Security benefits when saving for retirement

Whether you’ll have a big enough nest egg to retire comfortably depends not only on how much you save and invest over time but also, for most working Americans, on how much you’re likely to get in Social Security benefits.

Even if the benefits alone are not sufficient to provide a comfortable retirement for most people, they are still an essential income source.

Today, on average, Social Security benefits may replace about 40% of a person’s pre-retirement income assuming they start collecting benefits at their full retirement age. But that replacement rate may be much higher for low-income career earners or it may be much lower (eg, 28% to 35%) for those “high” or “maximum” earners. To be in those categories your earnings are often at or near the annual maximum income subject to the Social Security payroll tax. That income threshold goes up every year. This year, the tax applies to the first $168,600 of a person’s salary.

To anyone who discounts just how valuable Social Security benefits are for everyone, ask yourself how much you would need to save to replicate the same income stream, said certified financial planner Mari Adam, who specializes in women and money issues. For example, if a married couple expects to get $40,000 a year from Social Security, it could take $1 million in assets to replace that benefit, assuming you plan to withdraw roughly 4% a year from your portfolio. If you had to replace $24,000 in Social Security benefits, you might need a $600,000 portfolio.

Of course, there are less conservative withdrawal strategies you could adopt, which would lower the total savings you’d need to match Social Security’s income stream. Or you can probably buy an annuity to generate that income for less than the amount you’d need using a conservative withdrawal strategy. But in all cases, Adam said, “The point is it takes a lot of money to replace that benefit.”

If you have no idea what Social Security benefits are promised to you under current law, get an official estimate based on your average career earnings to date from the Social Security Administration. The estimate will be revised annually based on your latest earnings. And you should always check that your earnings are correct.

(To get a very rough, unofficial ballpark estimate, based solely on your current income, you can use the SSA’s “quick calculator,” but you’ll eventually want the fuller estimate.)

Keep in mind, however, that your future benefits may change: Roughly a decade from now, Social Security is projected to take in less revenue than it is supposed to pay out.

If lawmakers do nothing about that, the program would have to cut retiree benefits across the board by either:

21% in 2033: That is the year Social Security is projected to only have enough revenue coming in to pay out 79% of promised benefits.

Or …

17% in 2035: The cut could be reduced and delayed until 2035 if the Social Security retirement trust fund is merged with its trust fund for disability benefits.

Either way, such abrupt, steep cuts would be disastrous politically and practically. So the assumption is lawmakers would not let that happen. But no one can say now what lawmakers may do instead to make the program solvent for decades to come.

It likely would involve a series of adjustments — direct and indirect — that would affect benefits. For example, raising the retirement age, changing the benefits calculation formula and adjusting the payroll tax.

Many fear their benefits will be reduced. But, depending on the changes made, lawmakers could actually increase benefits for lower-income earners and keep them roughly the same for middle-income earners, according to Shai Akabas, executive director of the economic policy program at the Bipartisan Policy Center. His testimony before the Senate Budget Committee in September lays out a variety of options Congress might consider.

Some retirement savers just assume they won’t get any benefits by the time they retire. But that is an unlikely scenario.

“Social Security is not going away. It is perhaps the most popular government program and one politicians are so reluctant to touch,” Akabas said. “Benefits will be adjusted in the future as they have in the past, but the program will endure.”

In the meantime, when you’re trying to project what you’ll need to retire, Adam recommends most people should continue to use Social Security’s current estimates for you until they change.

That’s especially her recommendation for those within a decade or so of retirement since, she said, lawmakers are going to be most reluctant to change benefits for current retirees or those over 55.

If you prefer to be more conservative, you could just plug in 83% of your promised benefit estimates to see if you are saving enough now to compensate. Or if you want to be extra conservative you could assume you’ll get 50% of your promised benefits.

Chances are those more stringent assumptions will make it appear that you’ll fall short of the income you want in retirement.

If so, remember “there is a bunch of things you can do to account for Social Security being scaled back,” Adam noted.

Among them, you can aim to work longer and delay taking Social Security until age 70, which would mean a much bigger benefit than if you take it at 67 (which is the full retirement age for anyone born after 1959). Or, if you’re able, you might bump up your 401(k) contributions or savings in a Roth IRA. Or you might pay down your mortgage faster.

Whatever you choose to assume about Social Security, don’t assume the worst, Adam said. “You’re not losing 100%.”