As you know, Social Security is a program set up by the government to make sure that retirees don’t go hungry when they are too old to work. During your working years, you pay money into the program, which funds the benefits for people currently retired. When you retire, working people will be paying in to fund your benefit. But the question is: What is that really worth? How do you account for that in your retirement planning? And is it even worth considering?
Should you even consider Social Security?
A lot of people, myself included, usually don’t consider Social Security in their retirement planning. Based on current trends, Social Security is expected to be paying out more than it brings in. This is because people are having fewer children in recent generations. As a result, there are fewer people entering the workforce than there are retiring.
Thanks to better medical care and healthy living, people are also living longer now than before. If this trend continues, and payment policies don’t change then by 2036, reserves will be depleted, and benefits may have to be reduced. However, in reality, it will probably not go away. Most likely, changes in policy will help keep Social Security alive into the future.
So while I don’t recommend anyone rely solely on Social Security, it is money that you will most likely receive in retirement. It can have a real impact on your quality of life after retirement and reduce what you truly need to have before you retire.
How do you account for Social Security in retirement planning?
There are several ways to account for Social Security when it comes to retirement planning. In a lot of calculations, you’ll see people use net present value formulas or simply add up total projected payments. This can be useful, but it can be difficult to calculate and rely on several assumptions.
They also have accuracy problems to deal with. So for the sake of simplicity and accuracy, let’s look at what kind of money you’d have to have in your retirement account to reliably replace your Social Security check. This way, you can simply take the total amount that you figure you’ll need to retire, then subtract the value of social security to find how much you’ll actually need to have in your account.
So, what is Social Security really worth?
First, how much is Social Security? This is important in doing our calculations. According to the Social Security Administration, the average Social Security payment in 2015 for retired workers was $1,335 per month. The maximum payment, if you maximized your contributions, was $2,663 per month. That means an average annual benefit of $16,020, and a maximum of $31,956.
When I want fast calculations to help people plan for retirement, I usually use the 4% rule. The 4% rule is the most common safe retirement withdrawal rate quoted by experts. It assumes that you can safely withdraw 4% of your retirement account in your first year of retirement. Then safely maintain that amount for the rest of your life, even adjusting for inflation. So that means that if you want to live on $40,000 per year, then you need to have $1,000,000 in your retirement accounts when you retire.
So what does that translate into for Social Security? Using the 4% rule, that $16,020 average annual benefit is worth about $400,000 in retirement savings. To have that $40,000 per year income in retirement, you would only really need to save about $600,000 in your retirement accounts. So based on average benefits, Social Security already accounts for a nearly half-of-a-million-dollar retirement portfolio.
What about maximum benefits? The maximum is worth nearly $800,000. To retire today at 65 and have the benefit of a million-dollar retirement account, you would only need to have about $200,000 in your retirement accounts if you’re able to receive the maximum Social Security benefit. Delaying your retirement increases your Social Security payment, further increasing the equivalent account value.
The bottom line is that Social Security has real value in retirement planning. It can easily bring the value of your retirement portfolio to a million dollars when you consider the cash you’d have to have to replace it. Even with the concerns that surround Social Security in its current form, it can still provide value to people that are planning to retire decades from now. In my retirement planning, I see this as an estimate of scale. I know I won’t be able to calculate it to the penny, but it does tell me that Social Security could be worth $500,000 in my retirement accounts. That’s very different than $50,000.
Here are some of the sites I used as references when writing this article.
How do you consider Social Security in your retirement planning? Is it a staple, or is it just icing on the cake?
This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.
© 2016 Rip Wrapp