Retiree Portfolio Should You Count on Social Security?

Some folks don't include projected Social Security benefits when planning for retirement. Assuming that Social Security won't be around sounds like a prudent strategy, but it means that investors have to save more than they need to for retirement. Saving more than what's realistically required may postpone or sacrifice shorter-term goals, or reduce current living standards. A better idea: Base your calculations on a reduced benefit.

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By David Braze (TMF Pixy)
May 21, 2001

Reform of the Social Security system is back in the headlines. On May 2, President Bush appointed the latest government-sponsored commission to review the program that accounts for the biggest chunk of the federal budget. The new 16-member, bipartisan body is co-chaired by former Senator Daniel Patrick Moynihan and Richard Parsons, chief operating officer of AOL Time Warner. Charged with submitting a report this fall, the commission has been asked to make recommendations for the modernization and viability of Social Security using six principles:

  • Modernization must not change Social Security benefits for retirees or near-retirees.

  • The entire Social Security surplus must be dedicated only to Social Security.

  • Social Security payroll taxes must not be increased.

  • The government must not invest Social Security funds in the stock market.

  • Modernization must preserve Social Security's disability and survivors insurance programs.

  • Modernization must include individually controlled, voluntary personal retirement accounts, which will augment Social Security.

Expect the usual political posturing by the usual suspects. And also expect little action on whatever the commission recommends. On important matters, our Congress too often acts only when an unavoidable crisis is imminent. In my opinion, this problem has not yet reached the stage where it's serious enough for our courageous politicians to be willing to take any substantive reform action.

Yes, they know that according to the 2001 Old-Age, Survivors, and Disability Insurance (OASDI) Trustees Report, the Social Security trust funds are expected to be depleted by 2038. But our fearless leaders also know that's one year longer than the system was expected to survive last year. Obviously, then, things have improved. And any improvement postpones the crisis.

The Social Security trust's slight improvement in solvency means those who adamantly oppose any attempts to change the current system will challenge most strongly any recommendations the latest commission will make. The biggest holdup for reform will be the issue of "privatization," a feature that would permit participants to control voluntary personal retirement accounts.

I won't argue the merits or drawbacks of this proposal. While I tend to support it, there are some significant problems that must be overcome before anything remotely like it can be implemented. Many of these difficulties were outlined in Social Security Isn't an Investment Account. They were also debated quite extensively on the Social Security Reform board, so they don't need further discussion by me. Instead, my interest in the topic lies elsewhere.

Given that the Social Security system is in trouble and that at some point the system as we know it will change, is it realistic to factor Social Security benefits into your retirement planning?

Ah, there's the rub. It's easy to say, "No, I won't count on it. If I get a Social Security check, that will be gravy on top of my retirement savings." It often makes sense to play it safe and base your plans on conservative projections. But what does taking that position mean to your current standard of living or to the funding of shorter-term goals?

To see, let's look at two workers, one age 35 and the other age 45. They both earn $75,000 per year, and want to retire at that same level of income in today's dollars. Each expects to live to age 90. As of today, neither has set aside any money for retirement, but both assume they will earn an average of 9% annually on their investments. To receive full Social Security benefits, the 35-year-old must wait until age 67, while the 45-year-old must wait until age 66 and 4 months.

Using the above information, let's see how both workers will fare when they incorporate and then omit Social Security benefits in their retirement planning. We will ignore any potential impact of income taxes or inflation. That's because those items will affect only the size of our answers, not the underlying relationship between them. Social Security benefits for both workers will be computed in today's dollars using the rough estimate provided by the Quick Calculator available on the Social Security website. The table below shows the results of using the preceding assumptions.

                             35-yr-old           45-yr-old    
Annual income $75,000 $75,000 $75,000 $75,000 Social Security benefit 21,972 0 21,636 0 Retirement income needed from savings 53,028 75,000 53,364 75,000 Total savings needed at retirement 553,741 783,182 525,823 739,013 Annual savings required until retirement 3,097 4,380 8,137 11,437

Note that by ignoring Social Security benefits, the 35-year-old must increase annual savings by $1,283 per year, or 41.4%. The 45-year-old requires a savings boost of $3,300, or 40.6%. That increased savings must come from dollars that could be used to accomplish shorter-term goals such as funding a child's education.

Given the instability of the system, why should any worker count on Social Security? There are two reasons. First, total elimination of Social Security benefits is politically unrealistic. Many diverse political interests and influential groups will ensure that the heart of the program will survive. It will persist as the primary source of income to prevent poverty in old age, as well as one of the traditional savings legs that funds part of everyone's retirement income.

Secondly, while the system is projected to be unable to pay full benefits to recipients after 2038, even without any changes it will still be able to fund about 72 cents of every promised benefit dollar from the Social Security taxes paid by Americans still working. (For details, see the extensive Concord Coalition analysis published during the recent presidential campaign.) Therefore, even those who doubt that they'll receive the promised benefit should nevertheless consider incorporating that reduced amount in their income projections. As an example, the table below cuts the projected Social Security benefits shown in the previous table by 28%.

                             35-yr-old       45-yr-old
Annual income                  $75,000         $75,000  

Social Security benefit         15,820          15,578

Retirement income           
needed from savings             59,180          59,422

Total savings needed       
at retirement                  617,983         585,515

Annual savings required      
until retirement                 3,456           9,061

Given a "worst case" of only 72% of the full benefit, the new required savings represents an increase of only $359 per year for the 35-year-old as opposed to the increase of $1,238 in the previous example. That's only an 11.6% jump instead of the 41.4% increase. For the 45-year-old, use of the 72% benefit produces a savings increase of just $924 per year instead of $3,300, a jump of only 11.5% instead of 40.1%.

Is our Social Security system in trouble? Yes. Will it stop paying benefits? Nope. Don't fall for that pile of buffalo chips.

In addition to what you'll get from Social Security, do you know how much you will need in retirement? Do you know how much you should be saving now? The Motley Fool's Roadmap to Retirement Seminar can help you answer those questions, and more. You'll walk away with your own retirement plan! 

See you next week. As usual, post your comments on the Retirement Investing or Retired Fools boards.

Best to all... Pixy

Dave Braze believes Congress will delay any modifications to the existing Social Security system for at least two more presidential election cycles. Fortunately, The Motley Fool is all about investors writing for investors, so you can avoid any problem a Congressional delay may create by investing for retirement on your own.