As a senior, you'll probably count on Social Security as an important source of your financial support. But you can't afford to rely on it too much or take too optimistic a view about just how much retirement income your benefits will provide.
Unfortunately, many Americans do just that because they don't realize this simple truth about the role Social Security is designed to play in funding their later years.
Here's the reality about Social Security
Social Security is meant to help support you in your later years, but the operative word is help. The program was originally designed to be part of a "three-legged" stool to offer support for seniors. The three legs were:
- Social Security
- Pensions provided by employers
- Savings that retirees acquired over the years
For most people, however, the stool has just two legs now -- savings and Social Security. And Social Security benefits haven't been increased to make up for the demise of the employer-provided pension. That means retirees are left to rely more heavily on their savings to supplement retirement benefits.
Seniors will generally need a substantial amount of money invested in order to produce enough income to maintain their standard of living in their later years. That's because it's generally estimated that older Americans need to replace at least 70% to 80% of their pre-retirement income -- if not more.
Social Security can't come close to offering this amount of money. These benefits were designed to replace around 40% of pre-retirement income, which would leave seniors facing a 60% cut to their earnings after retiring from their jobs. This cut comes at a time when certain expenses, such as healthcare, tend to rise sharply.
How to prepare to supplement Social Security
Once you have a realistic assessment of what Social Security will do for you as a retiree, you can set a retirement savings goal that allows you to build the nest egg you'll need to cover the rest of your living expenses as a senior. You can estimate your own personal benefit by signing into your mySocialSecurity account or using the calculators available on Social Security's website. You may notice that the higher your earnings, the less of your income Social Security will replace, so the more you'll need to save to end up with enough.
You can also estimate the amount of income you'll likely need as a retiree by calculating your estimated final salary and assuming you'll need 80% of that amount. To do that, take your current salary and assume a 2% raise each year from now until retirement.
The difference between the income you'll need and the Social Security benefits you'll receive must come from savings. If you estimate your final salary will be $60,000, assume you'll need $48,000 in total income as a retiree, and your Social Security will produce $24,000, your retirement savings would need to provide you with $24,000 in annual income. If you anticipate following the 4% rule, multiply this number by 25, and you'll determine you'll need a nest egg of $600,000.
Knowing the truth about Social Security enables you to do this calculation accurately so you won't end up with a financial shortfall that destroys your retirement security.