It Is Difficult to Factor Social Security into Retirement Planning

The complexity of Social Security benefit formulas and insecurity about the program’s solvency make it difficult for individuals to factor it into their retirement income planning.

In testimony for a House Ways and Means Subcommittee on Social Security hearing titled “What Workers Need to Know About Social Security as They Plan for Their Retirement,” Laurence J. Kotlikoff, Ph.D., William Fairfield Warren Professor at Boston University in Boston, Massachusetts, pointed out that Social Security’s Handbook has 2,728 rules and its Program Operating Manual has tens of thousands of rules to explain these rules. “The rules and the rules to explain the rules are written in a language that no one can remotely understand unless they have spent years immersed in the system’s provisions,” he said.

What most people are doing is relying on Social Security’s calculators and staff in making their collection decisions, Kotlikoff contends, but Social Security’s calculators do not inform individuals about  the benefits they can collect based on their current, former, or deceased spouse. He adds that Social Security’s benefit calculators are used by Social Security’s telephone and local office staff, and he contends they produce benefit estimates that are generally incorrect. “This is thanks to the calculators’ default assumptions that the economy will experience no future wage growth or inflation,” he says.

According to Kotlikoff, “The most common question workers appear to ask is no question. Instead, they figure out when is the earliest date they can take their retirement benefit and apply at that date. They appear to have little or no idea about their eligibility for spousal, widow(er), divorcee spousal, and divorced widow(er) benefits, little or no idea about deeming provisions, little or no idea about Delayed Retirement Credits, file and suspend options, start-stop-start strategies, family benefit maximums, the Adjustment of the Reduction Factor that can mitigate the Earnings Test, and the list goes on.”

Andrew G. Biggs, Ph.D., Resident Scholar at the American Enterprise Institute, noted that in a 2010 study, he compared the benefits that near-retirees predicted they would receive to the benefits they actually received just a year or two later. He found significant numbers of near-retirees either over- or underestimated their actual benefits by a significant amount. One-quarter of respondents underestimated their benefits by more than 22%, and one-tenth underestimated them by more than 50%. One-quarter overestimated their benefits by more than 21% and one-tenth overestimated them by more than 100%.

Biggs said one might think that the Social Security Statement would address this issue by providing benefit estimates to workers each year; however, his research showed no improvement in Americans’ ability to predict their benefits even with wider distribution of the statement.

Biggs contended one problem with the Social Security Statement is the Social Security Administration (SSA) expresses benefit amounts in so-called “wage indexed dollars”–that, he said, are “incomprehensible to most Americans and essentially useless in terms of retirement planning.” According to Biggs, the effects of wage-indexing on the estimated Social Security benefits an individual sees in his Social Security Statement can be substantial. As an example he noted that a typical worker retiring 30 years from today will receive a nominal Social Security benefit of about $64,750 per year. Adjusted for inflation, that future benefit will be $27,683. “That’s a figure that a person planning for retirement can more easily understand,” he said. But that’s not the figure the person will see on his Social Security Statement. Rather, because the SSA wage-indexes his future benefits, the figure on his Statement will be just $17,982, which is 35% lower than the true purchasing power of his benefits.

Biggs said expressing a future dollar amount either in nominal dollars (meaning the actual dollar amounts that will be written on benefit checks) or in inflation-adjusted dollars, which represents the current purchasing power of those future benefits would be useful. “To the best of my knowledge, wage-indexed dollars are never used in financial planning calculations, are difficult to explain in plain English and are irrelevant to the “life cycle model” through which most analysts view retirement saving decisions,” he stated.

Hearing witnesses also discussed how continued solvency of the Social Security system is important to current and future retirees. The Social Security Board of Trustees reports the combined asset reserves of the Old-Age and Survivors Insurance, and Disability Insurance (OASDI) Trust Funds are projected to become depleted in 2033 (see “No Change to Social Security Depletion Date”).

Citing data based on the Census Bureau’s Current Population Survey (CPS), Income of the Population 55 or Older, 2012, Joan Entmacher, vice president for Family Economic Security, National Women’s Law Center, noted that for most Americans, Social Security is the main source of retirement income. For two-thirds of seniors in households that receive it, Social Security provides at least half of their retirement income. It’s virtually the only source of income (90% or more) for more than one-third (36%) of seniors.

According to Entmacher, the data shows only for seniors in the top 20% of the income spectrum is Social Security not the largest source of retirement income; their earnings are. But as seniors age, other sources of income shrink or disappear as they stop working and exhaust their savings. Thus, reliance on Social Security increases with age: nearly half (47%) of seniors 80 and older receive virtually all of their income from Social Security.

Social Security will continue to be vital for future retirees, Entmacher said, noting that defined benefit pension plans are disappearing, and the prospects for retirement savings accounts filling the gap when today’s workers retire are not encouraging. Data from the Federal Reserve Board’s Survey of Consumer Finance show that today’s workers also will rely on Social Security to provide a modest base of income they can count on for life when they retire.

Entmacher argued that today’s workers cannot afford cuts to Social Security benefits, whether as part of privatization plans that would replace secure benefits with risky private accounts, a lower and less accurate cost-of-living adjustment that would hit the oldest beneficiaries especially hard, or further increases in the retirement age. She noted that a one-year increase in the retirement age cuts benefits by about 7%, regardless of the age at which benefits are claimed.

Entmacher suggested lawmakers make high earners “pay their fair share,” and not have a limit on the amount of income subject to Social Security taxes. Other witnesses argued for a flat rate benefit payment.

Complete testimony of all witnesses can be accessed here.