Reaching a 75% RRR: Social Security

Having determined that a 75% RRR (retirement replacement ratio) is a sound target to aim for, attention can be focused on evaluating the retirement income sources that will get you there.

Today, Social Security is the most common and, for many people, the most important retirement income source. According to the US General Accounting Office (GAO):

Social Security benefits provide the bulk of retirement benefits for most households. As of 2004, annuitized pension benefits provided almost 20 percent of total income to households with someone age 65 or older, while Social Security benefits provided 39 percent. Social Security benefits compose over 50 percent of total income for two-thirds of households with someone age 65 or older, and at least 90 percent of income for one-third of such households.

While there has been speculation for many years that the Social Security system may collapse and not be around for future generations of retirees, the fact is that Social Security is relatively sound. The system does face financial challenges, but these are fixable. From a retirement planning standpoint, it is our position that Social Security should continue to be a fundamental component of most Americans’ retirement plans.

So what share of the 75% RRR target can Social Security be expected to fill? The GAO issued a November 2007 report on Private Pensions that provides some very useful guidance:

SSA defines a low earner as someone whose career average earnings are about 45 percent of the national average wage index (AWI), while a high earner has career average earnings of about 160 percent of AWI. The national average wage index for 2007 is $40,405. So, a “low earner” in the table above would have an income of $18,182 while a “high earner” would be $64,648.

Key Points

1. The lower your pre-retirement income, the larger the share Social Security will be of your target 75% RRR. Low earners can plan on Social Security replacing about 50% of pre-retirement income leaving another 25% to be filled by other sources. High earners should plan for Social Security to replace no more than 30% of pre-retirement income. The higher your earnings, the lower the Social Security replacement ratio.
2. 

   Click Image to Request a SS Statement

   More precise planning can be done using the personalized Social Security statement that is automatically sent to workers over age 25 each year. This statement contains a wealth of useful data to help you prepare your retirement plan including earnings history and projected benefit amounts. In addition to being a useful (and free) retirement planning, the Social Security statement affords you the opportunity to check for errors in you earnings history or personal data.

3. An important consideration is the age at which you begin to receive Social Security benefits. You can begin receiving benefits as early as age 62, and this is what most people do. But if you start your retirement benefits at age 62, your monthly benefit amount is reduced by about 30 percent. It is a good strategy to develop you retirement plan with the aim of not taking Social Security benefits until full retirement age. Not only will this ensure you receive a full benefit, it also reduces the number of retirement years you will need to finance.



4. Social Security is the easy part of retirement planning. From the discussion above, you should be able to get a pretty good idea of how much of your 75% RRR you can count on Social Security to provide.