Old Couple

If you're hoping to receive Social Security payments, it's important for you to understand exactly what you can expect from the program. That way you can prepare for your retirement with your eyes wide open and not wind up scrambling to make ends meet if what you get is far lower than what you were expecting.

Your benefit is based largely on three factors: how much you earn, the number of years you work, and the age at which you start to collect. The Social Security administration estimates that the average retiree benefit in January 2015 will be $1,328 per month after a 1.7% cost-of-living increase. Within the next 19 or so years, about a quarter of Social Security's benefit-paying ability is at risk, but even if those payment cuts come to pass, the rest of the program is expected to remain in place.

Is that enough?
For most people, that promised benefit amount won't be enough to cover their costs of living in retirement. Indeed, the chart below from Social Security indicates where Social Security fits among the primary sources of income among people aged 65 and older:

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Source: Social Security. 

At 35% of income for people aged 65-plus, Social Security does provide a substantial chunk of income for retirees. But check out the next-largest block: "earnings," which provides 34%. If you want to keep working past traditional retirement age, then more power to you. If you find yourself forced to keep working just to make ends meet, then that's a sign of a retirement plan that didn't work as hoped.

What lifestyle will you have?
At $1,328 per month, Social Security's typical benefit is about in line with a full-time minimum-wage job -- in fact, it's below the minimum-wage level in many states. While benefits rise each year in response to inflation, that inflation adjustment doesn't adequately cover the impact of rising healthcare costs, which generally hit seniors disproportionately hard.

Combine that typical payment level with the reality that Social Security's inflation adjustment doesn't cut it for seniors, and it starts to look like many seniors have to work, regardless of whether they want to work. Indeed, with Social Security and earnings constituting nearly equal portions of the average retiree's income, one might assume that many seniors work minimum-wage jobs to cover the costs that their Social Security checks won't.

Working a job you love well past a typical retirement age can be a great part of your lifetime plan. However, dragging your aching bones to a minimum-wage job just to keep yourself off the street is likely not part of your retirement plan.

What other income is in your control?
The other key sources of income from that chart are income from assets and income from a pension -- either government or private. If you still have a pension available to you, that income can certainly help you cover your costs, but pensions aren't nearly as prevalent as they once were. For most retirees, the best alternative to working is to draw "income from assets" -- in other words, money from your investments.

The best time to start building your investment portfolio is the day you draw your first-ever paycheck. Investing early gives you the longest window of opportunity to put time on your side and let compounding work on your behalf to grow your investment base. If, like most of us, you're past that point in your career, the next best time is now. The sooner you get started, the less you need to sock away with each paycheck in order to build a decent-sized nest egg for your retirement.

Why this matters to you
Once you retire, it gets harder to go back to work, particularly for the type of income you were earning during your peak earning years. For one thing, many companies are reluctant to hire and invest in people they don't think will work for them long. For another, your own health or physical capacity may start to diminish as you age, making it tougher for you to keep working, even if you do have a great job.

And of course, a key benefit of retirement is the ability to spend your remaining time on Earth in the company of your family and friends. Your ability to enjoy that benefit depends entirely on your ability to cover your costs in retirement. Social Security can get you part of the way there, but it's not likely to be enough to get you through a comfortable retirement.

Chuck Saletta has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.