How does Social Security fit into my retirement plan?

Personal Finance Motley Fool

(KenTannenbaum)

Social Security is America's largest retirement plan, by far. Almost nine out of 10 Americans age 65 or older receive Social Security, and for most retirees, Social Security is a crucial source of income that helps provide stability and financial freedom. Here's what Social Security means to your retirement, how much you can expect to get, and whether you should worry about Social Security's future or not.

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Social Security will likely be a major source of your retirement income

Social Security makes up 34% of the average beneficiary's income in retirement, according to data from the Social Security Administration. Forty-eight percent of married couples and 71% of single retirees rely on Social Security for at least half of their income, and millions depend on it for substantially all of their income. In a nutshell, whether you've saved well for retirement or not, your Social Security benefits will likely be a substantial source of your retirement income.

 

Experts generally suggest that in order to maintain quality of life after retirement, the average American will need about 80% of their pre-retirement income. Social Security is designed to replace approximately 40% of the average worker's salary, which translates to half of the average retiree's income needed to maintain their standard of living.

However, retirement income needs can vary significantly, meaning that not everyone will need 80% of their pre-retirement salary to live comfortably. Some may be quite comfortable with much less, while others may need more to retire the way they want to. In addition, the Social Security benefit formula is weighted in favor of lower-income workers, so it might replace significantly more or less than 40% of your income.

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How much Social Security can you (and your spouse) expect?

Your Social Security benefit is based on a formula that indexes all of your annual earnings for inflation, up to the Social Security taxable maximum each year, and considers the 35 highest-earning years. These are then averaged together and divided by 12 to produce your lifetime indexed average monthly earnings.

This average is applied to a formula to determine your primary insurance amount, or PIA, which is your monthly benefit if you were to retire at your full retirement age. Finally, since you have the option of claiming Social Security at any time between age 62 and 70, your benefit will be permanently adjusted higher or lower to compensate, if you claim at any age besides your full retirement age.

If you think this sounds a bit complicated, you're right.

Fortunately, you can get a good estimate of your future Social Security benefit that's based on your current work history from  the SSA. By creating an account at www.ssa.gov if you haven't done so already, and viewing your most recent Social Security statement, you can get an estimate of how much Social Security you should expect, as well as some other useful information.

As of June 2017, the average benefit for a retired worker was $1,369. Spouses who don't qualify for at least half of the other spouse's PIA are eligible for a spousal benefit that raises their benefit to as much as half of the higher earner's PIA. As you would expect, the average spousal benefit of $712 per month is just over half of the average retired worker's benefit.

But I heard Social Security may not be around when I retire

There are all sorts of myths and misconceptions going around about Social Security's financial health. You can read an overview of Social Security's finances here, but here's the quick version.

Despite what you might have heard, Social Security is not "broke." The program had $2.85 trillion in reserves at the end of 2016, and is expected to run surpluses for the next several years. However, due to the ongoing retirement of the massive baby boomer generation, deficits will begin in a few years and last for the foreseeable future. As of the most recent projections, the Social Security trust fund is expected to completely run out of money in 2034.

While this sounds bad (and it is), it's important to realize that payroll taxes will continue to flow into Social Security after it's out of money, and this incoming revenue stream will be sufficient to cover 77% of benefits all by itself. In other words, as a worst-case scenario, Social Security will be able to pay 100% of your benefits for the next 17 years, and just over three-fourths beyond that.

In addition, if history is any indicator, something will be done to fix Social Security, even if it's just a temporary solution. Most of the American public on both sides of the political spectrum overwhelmingly feel that Social Security is worth saving, even if it means higher taxes, and there are several viable ways we could fix Social Security. And when Social Security's financial stability declined in the past, the government stepped in. In fact, the last major Social Security overhaul, which took place in 1983, is the reason the full retirement age is gradually increasing now.

The Foolish bottom line

To make a long story short, Social Security will likely be a significant source of income for you in retirement, so it should be a major consideration in your retirement planning strategy. Social Security isn't going anywhere, so it's a good idea to know roughly how much you can expect so you can plan the rest of your retirement savings accordingly.

 

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