The other day I posted a short article on HubPages called Can Social Security Turn A Meager Retirement Account Into A Million Dollar Portfolio. In it I talked about what Social Security is really worth when it comes to planning for your retirement. Below I talk a bit more about Social Security and using it in your retirement planning.
In its simplest form Social Security is money that the government sends you when you’re old to help you pay your bills. The Social Security Act that sets that up covers a number of social welfare and insurance programs, but for today we’re going to focus on the retirement benefits.
How Social Security works, in a nut shell
When you get paid by your employer some of that money is taken out for Social Security. It’s one of the many taxes. You end up paying 6.2% of your income to Social Security for all money you make up to $118,500. Your employer pays 6.2% of your income up to $118,500 to Social Security as well.
That money is used to pay the Social Security benefits of retirees and people on disabilities. Anything left over is saved in reserve by the Social Security Administration (SSA). When you reach retirement age the money current workers are paying will go to pay your benefits. That amount of that benefit is based on a formula set up by the SSA. It is based partially on how long you worked about how much you paid in.
For the most part this has worked fairly well. Unfortunately, now the SSA is paying out more than the taxes it’s bringing in. Estimates vary, but at the current rate the SSA will use up all of its reserves in the 2030s. That means that if nothing changes benefits will have to be reduced after that date.
It’s not all bad
Over the years policies have changed. It’s pretty much guaranteed that policies will change again to make sure that Social Security still exists in the future. So even if you have decades until retirement age you will most like still receive benefits.
So what’s it worth?
So then the question is what is it worth? Well, when you calculate how much money you need to have saved to retire you look at how much you need per year. Then you figure out how much you’ll need to have in your retirement account to make you that much every year. For this example we’ll follow the 4% rule. The 4% rule says that you can safely withdraw 4% of your retirement account the first year. And maintain that same amount each year adjusting for inflation. So let’s say you need $40,000 per year to live off of. To figure out how much we need to retire to have $40,000 we divide the 40,000 by 0.04 (4%). 40,000/0.04 = 1,000,000. So to safely withdraw $40,000 each year you will need to have $1,000,000 in your retirement account to retire.
So how does Social Security play into this? Well, once you reach retirement age Social Security pays you. According to the SSA the average Social Security payment last year was $1,335 per month. That comes out to $16,020 for the year. So that means that since Social Security will cover $16,020 of your $40,000 you won’t have to actually save the entire $1,000,000. Using the 4% rule how much is that $16,020 worth? 16,020/0.04 = 400,500. The average Social Security retirement benefit of $16,020 per year is the same as having $400,500 in your retirement account. That’s nearly half of the amount that you need to save. That also means that the average worker in America has a retirement nest egg worth about $400,000 thanks to Social Security.
So what do you really need to save?
That means that if you want to live off of $40,000 per year in retirement, and you count on Social Security, you really only need 1,000,000-400,500 = $599,500. Social Security could be half of your retirement account.
A truth to remember
I don’t want to stop you from working to reach your maximum goal. Social Security is pretty reliable, but the government can change the program at any time. That means the benefit could be reduced, either through legislation or because it doesn’t have the funding. But don’t discount it completely.
Do you plan to use Social Security? How do you account for it in your retirement planning?