A Social Security Reality Check

Jan 5, 2011

Once upon a time, workers were told that Social Security was but one leg of a three-legged stool that would support them during retirement. Private pensions and personal investments would serve as the other two legs. As time passed, most employers eliminated their pension plans. Instead of defined-benefit plans, workers were given access to defined-contribution plans. The three-legged stool then became the two-legged stool.

Looking Back at Social Security Benefits
As time passed and the economy faltered, investment values plummeted; the S&P 500 fell by nearly 40% at one point during the Great Recession, and many actively-managed portfolios fell even more than that, wiping out a significant portion of workers' wealth in a single year. Hurt by the economic downturn, many employers stopped funding their defined-contribution plans, further hurting the workers' ability to fund their retirement.

As a result, with severely depleted savings and no pension plans, many workers found themselves sitting on a one-legged stool. Looking to the future, they may see Social Security as their sole source of retirement funding. While it's true that the Social Security program was created to help workers supplement their retirement income, the program was never intended to be the sole means of support for retirees. And worse yet, the program is in trouble.

Looking Ahead at Social Security Payout
In 2010, the future solvency of the Social Security program was in question and the contribution to retirement funding provided by Social Security was expected to decline. The government predicts that by 2037, the Social Security fund would be exhausted according to the 2010 OASDI Trustees Report.

Looking at that scenario in today's dollars, a person retiring at full retirement age would be entitled to a payout of about $2,300 per month and just under $28,000 per year. That number is based on earning the maximum taxable wage base every year of one's career from age 21 through age 66 (which was $106,800 in 2010 and indexed annually). Assuming you make that kind of money, which few people do, that's $2,300 per month.

Of course if you were making $106,800 per year you would probably be able to save some of it for retirement, but what about someone earning the average income, which has been in the $35,000 to $50,000 per year range? Funding a retirement becomes much harder and Social Security payments would amount to even less. Getting a check is likely to become even harder in the future, as the age at which workers become eligible for full benefits is likely to be extended. At some point in the future, age 70 may be the norm for collecting full benefits.

Do the Social Security Math
Investors who are fortunate enough to retire at the tail-end of a stock market bull run and are wise (or lucky) enough to cash out have a good chance of enjoying their golden years. Those unlucky enough to retire during or after a bear market may be forced to delay retirement. For example, the Great Recession of 2008 was a game-changer, erasing a decade's worth of gains. The outlook for a financially secure retirement presented a troubled vision for a significant number of investors at the time. Few workers can afford a double-digit drop in the size of their nest eggs as they approach retirement age.

What can you do? Start by making a sound assessment of your situation. First, look at your projected income. What is the balance of your retirement savings? What do you realistically project that balance to be when you reach retirement age? Assuming a 4% drawdown rate on your retirement savings, how much income can you anticipate on a monthly basis? How much do you expect to earn from Social Security?

Now look at your expenses. How much do you spend today? What percentage of that do you anticipate spending in retirement? If there is a shortfall between your expected earnings and your expected savings, you'll need to consider your options for closing the gap. Working longer, saving more and downsizing your expectations may all be required.

Retirement Reality Check
If retirement is still on the distant horizon, you may be able to get back on track by increasing the amount you save each month. If retirement is looming but your funding is lacking, a revised spending plan may be in order. If your expected income won't cover your expected expenses, some expense reduction may help you keep your retirement date on track.

The Bottom Line
If no amount of cost cutting will get your income and expenses to line up, it may be time to rethink your retirement. Extending the date at which you plan to retire and taking a part-time job are two options to consider. Even if you remain on track despite the market doldrums, memories of the last bear market are a good reminder to remain vigilant - you never know what the future has in store.

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