Friday, August 18, 2006

Retirement Planning in Your 20s (And Beyond), Part 2: Consider Social Security

Welcome back as I continue to try figuring out what I'll need for my (long-distant) retirement. Part One was on estimating retirement expenses. Today's topic: should I consider Social Security in my planning, and if so, how?

I'm guessing most people are making plans assuming you'll get nothing from Social Security. That's certainly the safest route. But on the other hand, I'm in my 20s. As I try to come up with this estimate of needs, I'd like to try to be as realistic as possible. If I turn out to be unnecessarily optimistic, I've got decades to course-correct. (And besides, I'm not planning to change anything about my savings at the moment-- so this estimate is just informational.)

Of course, at first I thought that "$0 (or very little) from Social Security" was the most realistic estimate. But reading up on it, it looks like Social Security isn't predicted to go broke until I'm 60 or 70-- and broke only means that the trust fund will be depleted and inflows would have to cover outflows, which means benefits would fall to about 75% of their promised levels. 75% isn't great, but it's way, way more than 0%. (And that's if no action's taken to improve the system so benefits don't need to be cut.)

The Social Security calculator projects my benefits would be the equivalent of $17,000 a year in today's dollars (after adjusting the earnings projections to make them more conservative). 3/4 of that is $12,750. Heck, even if benefits get cut in half, it'd be $8,500. That's certainly not enough alone for me to live on-- but it's not peanuts.

As I discussed in Part 1, I'm estimating my annual retirement living expenses at $25,000 (in 2006 dollars). So a reasonable estimate (although obviously not fool-proof) is that Social Security would cover between 1/3 and 1/2 of those expenses. Not too shabby.

I'll use the 50%-of-promised-benefits estimate to be on the safe side, which suggests I'll need $16,500 a year (in today's dollars) from my investments. Check in next time as I try to estimate how to produce that.

In the meantime: how do you handle Social Security in your planning, and why? I'm personally trying to come up with a reasonable, realistic estimate here, not the most ultra-safe one. But I guess you can't go wrong assuming you'll get nothing and being pleasantly surprised when/if you do (unless it leads you to make sacrifices in the present which on balance you'd rather not make). So, folks, do you count out Social Security entirely? If so, is it because you believe you'll get nothing from it, or do you figure you might/probably will get benefits but it's just safer to focus on your own retirement savings?


traineeinvestor said...

I assume I will get nothing from the state when I retire. One of the reasons for this is the expectation that benefits will be means tested by then as a means to reduce the costs of providing social security etc. I hope that if my savings and investing plans stay on track my means will be above whatever threshold is set.

jay said...

I'm in my early 20's as well. I plan on having enough saved that SS would be just an extra bonus. I think for planning purposes young people shouldn't count on it. However, it's absurd to think we won't derive some benefits from it. If it is privitized years down the road, I imagine benefits would be pro-rated, or accrued benefits would rollover. But due to this uncertainty, it should probably just be ignored.

Foobarista said...

My "zero assumption" is based on the idea that SS will likely become means tested and become essentially a welfare program for elderly poor. The argument for _not_ doing this is a sort of "social psychology" argument that is not going to be worth the trillions needed to maintain the argument.

So, if you save for retirement, you'll likely be too wealthy to pass the means test.

mOOm said...

I don't think the US government will renege on benefits already promised. But what they could do is say - hmm you have $20,000 in contributions so far. If you quit work now you would get $x from social security. We will guarantee this level of benefits, but from now on contributions will earn less in future benefits. Remember that the $17k you quoted is based on you working till retirement age. It isn't the benefit you would get if you never worked again from today on.

So to work up a minimum savings figure I would put down how much social security you would receive if you quit work today and never worked again. You can adjust the number over time as you accumulate social security contributions and future benefits. There are online calculators available. Most of the benefit from social security comes from the initial contributions. Above a given income level or length of contributions the additional benefit falls off steeply.

So far I have only made 5 years of social security contributions. So I need another 5 years till I "vest". This is because I am an immigrant.

Australia only pays the "pension" to poorer old people and means tested. it doesn't depend on contributions. The maximum payment is very low. There is compulsory saving in retirement schemes including a 9% compulsory employer contribution. So Australia is basically an entirely privatized system with a backup welfare payment.

Penny Nickel said...

That's an interesting point about means-testing, I hadn't thought of it that way. Thanks for your comments!

brokenboy said...

My issue at the age of 29 is that interest rate is EVERYTHING when you have this many years to invest.

When I do investment calculators, I see that if I get a 6% return on my money for the next 35 years, I may not hit my goals, and I'm saving almost 50% of my income. If I get 9%, I'm pretty much on track. If I hit 11%, I could have stopped puting into my 401(k) when I was 25 and I'd be fine forever. At 13%, I could pretty much retire now.

When I do these calculations, I'm always assuming no SS since that's just as variable at this point as the interst rate is. I think all you can do in your 20's is save as much as you can and hope. The result of the SS payments will be dwarfed by the variation in interest rate when you are this young.

If I knew the interest rate that I could earn over the next 30+ years, I would totally change my strategy, As it stands, I take the pessimistic view that I'll make 2% above inflation, and that scares me into saving everything I can.

Omar Cruz said...

I like this blog is fantastic, is really good written. Congratulation. Do you want to see something more? Read it...:Great investment opportunity in Costa Rica: beach real estate, condo, condos for sale. Visit us for more info at: