The 5 Years Before You Retire: Retirement Planning When You Need It the Most | Chapter 5: What to Expect from Social Security

For most Americans, the main (and often only) decision regarding Social Security is this: When should I start my benefit?

That means our job is to give advice to our clients on when they should start this lifetime income stream, all things considered (including someone’s fears about the solvency of the program).

Birken does a good job summarizing the mechanics of Social Security, all of which we take into consideration when advising clients on when they should start their benefits. This includes

• What your “full retirement age” is according to the SSA

• What decrease in benefits you will receive if you start before that

• What increase in benefits you will receive if you delay up to 70

• The annual increase to Social Security income (Cost of Living Adjustment or COLA)

• The taxation of Social Security

• What spousal benefits are available and how to maximize for a household

I won’t re-type all the details (the chapter is a short enough summary), but there are two items I want to highlight here. Firstly, how the program works and why there are concerns for its longevity.

Every paycheck you get from work has a total of 12.4% that goes to fund Social Security (half from you, half from your employer). Let’s say your salary is $100,000 before taxes. That means in a given year, $12,400 will go towards Social Security. Unlike a retirement account (401k, IRA, etc.), these funds do not go into an account to grow and be waiting for you when you retire. Your money goes to those who are currently receiving their Social Security income. The plan is that when you’re receiving income, your paychecks will be funded from those still in the workforce.

Imagine two consecutive waterfalls, connected by a pool between them. The first waterfall feeds into the pool in the middle, and the pool then turns into a second waterfall. Everybody paying into Social Security is like the first waterfall that flows into the pool. Everybody receiving funds from Social Security is like the second waterfall, pulling water out of the pool. The issue with Social Security is that water is flowing out of the pool (and down the second waterfall) faster than the first is feeding into it. As a result, the pool is getting smaller. The “Social Security is running out of money” problem does not mean that all benefits will be gone (that the waterfall will dry up). It means the pool in the middle will be gone (which is stored from when the upper waterfall was flowing faster than the second between 1985-2009). The worst case scenario that’s on the table is that the pool/surplus dries up, and the second waterfall shrinks to the size that can be supported directly from the first waterfall. As Birken notes, even if this happened, we would still be able to fund 75% of benefits until 2093. A solution to avoid reducing benefits would be to increase the rate of flow of the first waterfall - to increase the taxes on those currently paying into the program.

Before we go further, here’s a quick anecdote on what Social Security costs Americans.

Let’s go back to the individual earning $100,000, which has $12,400 going to Social Security annually. Multiply that by 40 years in the workforce, that’s ~$500,000 in today’s dollars. If we were looking at saving that into an investment account with a modest 5% (after inflation) average annual rate of return, that would leave you with $1,500,000 at retirement, again in today’s dollars.

If someone had this earnings history, their monthly benefit in today’s dollars would be about $3,300/month, or $40,000/year. This is the equivalent to a 2.6% annual withdrawal rate - not something to write home about. A common starting point with funds managed by an advisor is a 4% withdrawal rate, which equates to $5,000/month or $60,000/year. So for someone earning $100,000, what does their Social Security cost them? About $1.5 million in terms of assets, or about $2,000/month, $24,000/year in income. While many love their Social Security income, they don’t realize what the opportunity cost is.

The second item to discuss is how Brockmann Financial takes all the information about how Social Security works, your personal financial situation, your feelings about Social Security, and your defined goals, and then determines when a client should start Social Security. This will be the subject of next week’s post.

Let us know

• What particular mechanic of Social Security is new information to you?

• Have you ever heard anyone complain about their consistent, annually increasing income from Social Security?

Until next time, happy reading!