You hear it all the time, particularly if you read too many financial blogs:
“I’m not counting on Social Security to be there when I retire, so I’m ignoring it in my retirement planning. If it’s still around, it’ll be a nice bonus.”
In other words, to be prudent, we should treat Social Security like the inheritance we might get from an eccentric uncle with mysterious finances. When you hear someone say this, however, you can be sure that the speaker is (a) very wealthy or (b) doesn’t understand what ignoring Social Security actually means.
Before I get into the details, a disclaimer: this column is not about the long-term solvency of Social Security or Medicare. For this blog, that’s an off-topic political question, and I have no more insight than anyone else.
The question I want to ask is: if you’re skeptical about the future of Social Security, are you actually saving enough to protect yourself if it goes bust? Or are you just complaining about car thieves without putting a Club on your Buick?
What’s it worth to you?
Let’s assume, for the moment, you believe Social Security is as safe a brick sh—uh, house. You can visit the official Social Security Estimator and find out what your expected monthly benefit is, in 2012 dollars. (If you want to learn all about how the Social Security Administration figures your benefit, I highly recommend the book A Social Security Owner’s Manual, by Jim Blankenship, which is not only thorough but funny. Really.)
Because my wife makes more than I do and I’ll be eligible to claim her spousal benefit, I entered her information. Her expected monthly benefit at full retirement age (67) is $2688. The spousal benefit is 50%, so that comes to a total of $4032/month or $48,384 per year. Yes, this is oversimplified and ignores taxes; if anything, it underestimates the payout we could receive if nothing changes between now and 2043.
Now let’s say Social Security goes away. How much money would we need in order to be able to withdraw $48,384 per year, starting at age 67 and lasting for the remainder of our lives? And how much more would we need to save now in order to get there?
There are many ways to calculate how big a lump sum it takes need to produce a given amount of retirement income. One way is to price an inflation-adjusted immediate annuity with survivor benefits (I know, snooze alert!) from an insurance company. I went to Vanguard’s Income Solutions platform and did so.
The result: to purchase an annuity to replace our promised Social Security benefits would cost about $1.09 million. That’s not inflated future dollars; that’s today’s dollars.
Alternatively, say we don’t trust an insurance company any more than we trust Uncle Sam. Instead, we could use the 4% portfolio withdrawal rate rule of thumb. Well, that’s even worse: now we need over $1.2 million.
But hey, my wife and I are still young. Let’s say we have 30 more years until full retirement age. How much would we have to bump up our savings each month to amass $1.09 million to purchase that annuity? It depends how much we expect to earn on our savings. Since we’re talking about the difference between living in abject poverty and relative comfort in retirement, we can’t invest heavily in stocks, so let’s assume a real (inflation-adjusted) return of 2%, which is probably generous.
To replace Social Security, we have to increase our monthly savings by $2215. Ouch.
Now, the average Social Security benefit is much lower than $2688: it’s $1177 as of 2011. But that ignores spousal benefits, and it reflects the fact that most retirees take Social Security at age 62 rather than full retirement age of 66 or 67. If your income is lower and you need your savings to last for five more years of retirement, it’s going to be that much harder to replace Social Security out of your own pocket.
The other gorilla
Actually, it’s much worse than that.
Social Security is only one of the two big federal entitlement programs. Medicare is already a larger slice of the federal budget and is growing much more rapidly than Social Security. (Both slices include programs for the elderly and for the non-elderly who are poor or disabled.)
Again, I’m not taking a position on the solvency of these programs, but to return to our earlier analogy: if you believe Social Security is headed for bankruptcy and you aren’t worried about Medicare, you’re putting a Club on your Buick while it’s on fire.
Let’s say—and this is too conservative, given rising healthcare costs—your promised Medicare benefits are about the same size as your social security benefits. Now instead of an extra $2215, I should be saving twice as much, $4430, in order to purchase an individual health insurance policy at age 65. Do you have something handy for me to beat my head against? Thanks.
I’m going to say it one more time, because this is an emotional topic that invites partisan invective: I’m not offering any opinion on the future of Social Security and Medicare. What I’m saying is, if you personally believe you’re going to be on your own for retirement, you have two options:
Save like the miserly love child of George Costanza and Scrooge McDuck
Plan to work till you die or Social Security turns out to be alive, whichever comes first
Complaining about fiscal irresponsibility but failing to save enough to cover your own retirement isn’t on the list.