When you get serious about crafting a solid retirement plan, you need to understand how to read your Social Security statement. If you have yet to claim your retirement benefit, get your most recent statement online at www.ssa.gov/myaccount and read below.
Income Assumption
On page 2 of your statement, you’ll see your estimated retirement benefits at age 62, “Full Retirement Age,” and 70. Each of these estimates assumes you work through each respective age. Don’t plan on working to age 70? Then your age 70 estimate is likely overstated. Plan on retiring in your 50s? Then all of your estimates may be overstated.
Social Security takes the highest 35 years of earnings, adjusted for inflation. If you started working full time in your early 20s, you’d get 35 years in by your late 50s. Or you continue to work and earn a higher inflation-adjusted income in your later 50s than you made in your 20s, then the lower-income years from your 20s will be replaced.
Or suppose you stayed home for a decade to raise your children and later returned to Social-Security-covered work. In this case, you may not reach 35 years of earnings until your late 60s. If you retire earlier, your benefits at later ages on page 2 may be significantly overestimated.
The estimates are made assuming “your current earnings rate.” This means what you earned last year will be how much you continue to earn each year after that until retirement. If there are no reported earnings from the prior year, but there are earnings from the prior-prior year, the earnings from the prior-prior year will be assumed. If neither exists, the Social Security Administration will project that there will be no future earnings.
Today’s Dollars
Estimated retirement benefits are reported in today’s dollars and not future dollars, given cost-of-living adjustments received over time. Providing the benefit in today’s dollars is a good thing. It’s easier to think in terms of today’s dollars rather than assuming inflation rates, doing math, and then thinking about future dollars.
Social Security benefits shown on an individual’s statement will be increased over time, via inflation adjustments, in two distinct ways. A worker’s wages through age 60 are indexed for inflation using the National Average Wage Index. Once eligible for benefits, benefits will be increased for inflation using cost-of-living adjustments (COLA) determined using the Consumer Price Index for Urban Wage Earners and Clerical Workers, or CPI-W. Historically, increases in the National Average Wage Index have outpaced increases in the CPI-W. (Note there’s a quirky, two-year gap from age 60 to age 62 when no inflation adjustment applies.)
You may have heard of “chained CPI.” This is another measure of CPI that accounts for substitution effects you may make when prices rise. Honeycrisp apples too costly? Perhaps Red Delicious will do. The net result of chained CPI is that it tends to be a little less. While the difference is small, it compounds over time.
And importantly, chained CPI made its way into law with the Tax Cut and Jobs Act of 2017 and now impacts inflation increases in income tax brackets each year. It’s also a less overt way to fill Social Security’s funding gap partially. I believe it is likely to be included in the Social Security fix … whenever politicians get around to it.
So while today’s dollars are easy to understand, you or your advisor still need to consider inflation increases smartly.
What’s Missing
If you want to understand how your retirement benefit would be impacted through the Government Pension Offset or Windfall Elimination Provision, both commonplace in Ohio since public employees do not pay into Social Security, you’re out of luck. Or if you want to understand your spousal benefit or how what claiming strategy will likely help you optimize what you receive, the statement won’t help there.
While understanding your Social Security statement is an excellent first step to building your retirement plan, it’s just that.
You’ll need to be sure to have a reasonable estimate of your lifestyle and healthcare expenses and how they will change as you age. You need to then make smart decisions on your Social Security and pension claiming strategy. Next is aligning your investments to support your overall plan, and lastly, you should overlay your entire plan with tax-smart strategies to keep more in your pocket.
With low-interest rates and parts of the stock market being quite rosey in price, a good plan is more valuable today than ever.
