Part 1: Social Security
Back in the day, Social Security was referred to as one of the legs of a “three-legged stool” for building retirement security for Americans. The other two were private pensions and personal savings. The metaphor has been attributed to President Franklin Roosevelt in his conceptualization of Social Security, but the Social Security Administration’s Historian’s Office (yeah, that was a big surprise to me, too) denies Roosevelt said it.
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| Figure 1. FDR's Three-legged Stool. |
Companies used to offer private pensions to employees who promised to work for them for thirty or forty years. Your grandfather left his job at General Motors on his retirement date and the company kept sending him checks for the rest of his life. Nowadays, private pensions are rare and becoming more so.
Social Security benefits, which are constantly under attack by fiscal conservatives, now combine with your personal retirement savings to form a two-legged stool, I suppose, so sit carefully (metaphorically speaking).
The three-legged stool of 75 years ago now looks much less stable with pensions a mere shadow of their former selves and one of those legs, Social Security, showing some stress.
In planning retirement, one of the first steps is to determine how much income we will be able to generate after we leave those employee paychecks behind. We would like to know, for instance, that our Social Security benefits will total $3,000 a month, our savings can generate another $2,000 each month, and that small pension from our employer will add another $250, so we can count on $5,250 per month of income after we retire.
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| The "new and improved" stool. |
Social Security Benefits
It’s simple enough to find out what Social Security benefits we are entitled to. It’s a bit more difficult to identify the particular benefits we should claim and when we should claim them in order to maximize our income.
You can estimate your benefits using one of three benefit calculators, depending on how much data you want to provide, at www.ssa.gov. The simplest calculator asks only your date of birth and how much you earned last year.
You can also call the Social Security Administration (SSA) at 800-772-1213 and request a benefits statement. SSA mails a statement of my benefits and my wife’s to my home annually, but they claim they will have everyone’s benefit statement online by the end of 2011 and will stop the mailings.
Be prepared to receive not one, but at least three different monthly retirement benefits quotes, because the amount of the benefit depends on the age between 62 and 70 at which you choose to begin receiving benefits. You will likely receive an estimate for the earliest retirement age, full retirement age, and the maximum payment at age 70, and you may receive a quote for all nine possible retirement ages 62 through 70. The following table from SSA’s website illustrates this.
Social Security Retirement Benefits
You are eligible for social security benefits if you are at least 62 years old and you have paid FICA taxes for at least forty calendar quarters. That’s ten years total, and the quarters don’t have to be consecutive.
Social security benefits are an annuity, meaning your benefit amount is paid for as long as you live. Those benefits are also increased over time to compensate for inflation. Most private pensions and fixed annuities are not, and even a relatively low long-term inflation rate of 3% can destroy your purchasing power by the end of a 30-year retirement. The $1,320 monthly benefit shown for age 70 in the SSA’s chart above will grow with inflation and should still be worth about $1,320 of today’s purchasing power at the end of your retirement, even though the check would be written for more than $3,000 by then.
Your monthly benefit amount is based on your full retirement age, which is determined by the year you were born. For those of us born in 1952, current law defines full retirement age as 66. You can begin receiving benefits at age 62, but the amount of the benefit will increase about 8% for every year you wait to receive benefits, until they max out at age 70.
Once you select a date to begin receiving benefits, you are “stuck” with that amount for as long as you live (with a few exceptions that I will explain later). If your benefit is $1,410 monthly at age 62, for example, you can retire at age 62 and receive $1,410 monthly, adjusted for inflation, for the rest of your life. If you wait until age 63 to receive benefits, you will receive no benefits while you are 62, but beginning at age 63 you will receive $1,523 per month for life, again adjusted for inflation. Think of that extra $113 per month as a “reward” for not receiving benefits the year you were 62.
If you can postpone receiving benefits until you are 70 by working longer or paying for those early years from your 401K savings for example, you can increase your monthly payments by a whopping 85% over what you would have received at age 62. There are advantages and disadvantages to postponing benefits, though, which we will consider later.
Spousal Benefits
What if you are 62 but never worked or worked for fewer than 40 quarters? Then you’re not eligible for social security retirement benefits — unless you are married (or were married for at least 10 years) to someone who did work and is eligible for benefits. In that case, you’re probably eligible for spousal benefits.
Spousal benefits are based on your spouse’s social security retirement benefit that he or she would receive if he or she retired at full retirement age. It doesn’t matter what age the working spouse actually begins receiving benefits, or if they receive them at all. Your spousal benefit will still be based on the working spouse’s full retirement age benefit amount.
Your spousal benefit will be up to half the working spouse’s full retirement age benefit. That’s “up to half” because the benefit will be reduced if you decide to receive your spousal benefits before your full retirement age, same as your own benefit would be.
Both Spouses Worked
In many households today, both spouses worked and paid FICA taxes and each will be eligible for their own benefits and spousal benefits. In that case, the Social Security Administration will automatically calculate both worker and spousal benefits for each spouse and send each spouse the payment that is larger.
There are several volumes of SSA rules, but these few are all we need for our current purpose, determining a ballpark estimate of the retirement income we can expect. Many are explained at SSA.gov, but please call the SSA or a financial planner if you have questions. Making the wrong decision can cost you a lot of money.
As an initial planning step, however, these few rules combined with benefit statements from the SSA allow us to begin the retirement planning process.
Don’t be overwhelmed by the range of options to receive Social Security benefits discussed here (it’s actually even more complex!). What I really want you to focus on is the fact that there are a number of decisions to be made regarding when and how we begin to receive Social Security benefits and those decisions have a substantial impact on how large our benefits will be.
We can postpone those decisions at this point, however. I suggest you estimate your benefits at full retirement age to begin planning and then work on maximizing them later.
The Disappearing Third Leg
I dismissed the private pension leg of our famous three-legged metaphor because so few people receive them anymore, and that isn’t quite fair. There are still a few around. If you are lucky enough to have become vested in one, contact your plan administrator to ask for a benefits statement, or dig out the last annual statement they were supposed to send you in the mail.
There are two very important issues with private pensions that you will need to address. First, determine if your benefits are adjusted for inflation. If they are not, those payments will become less and less valuable as retirement moves on. A $1,000 monthly benefit without inflation protection will be worth only about $400 of today’s dollars in thirty years, even if inflation averages just 3%.
The second thing to remember is that private pension plans sometimes fail. That’s a risk you’ll need to consider, but John and Sara don’t have that luxury. Their employers didn’t provide pensions.
Not Covered by Social Security
For historical reasons, some public workers are not covered by Social Security, but have their own retirement plans. They pay into those retirement plans while they work instead of paying Social Security taxes. Railroad workers, for example, have their own retirement plans in lieu of Social Security. Public school teachers in fourteen states[2] do not provide Social Security coverage for teachers, but cover them under separate retirement plans.
If you’re not covered by Social Security, you’ll just need to unscrew the Social Security leg of your stool and replace it with your retirement plan leg (plug in your retirement benefits amount in place of the Social Security estimates).
If You’re Playing Along at Home
If you would like to calculate income for your own plan, you can record your benefits in this section.
Track down a recent Social Security benefits statement or use the estimate calculators at the website referenced above to find the data you need or use the retirement calculator to access your personal benefits information. You will need to calculate your benefits estimate at earliest retirement age (currently 62), full retirement age (currently 66) and at age 70, and calculate the same information for your spouse if you are married.
You | Your Spousal Benefit | Spouse | Spouse’s Spousal Benefit | |
Benefits at earliest retirement age ____ | ||||
Benefits at full retirement age ____ | ||||
Benefits at age 70 |
At what age can you afford to retire? Can you afford to pay your expenses from personal savings for a few years while you delay receiving Social Security benefits and thereby increase them? Should you work a few years longer to increase your savings and delay Social Security benefits? These questions are largely dependent upon how much you have saved. We’ll look at personal savings in Part 2 of The “Two-legged” Stool.
The Key Points
Here are the key points to remember from Part 1:
o The bulk of your retirement income will likely come from personal savings (401Ks, IRAs, etc.) and Social Security benefits.
o You can begin receiving Social Security retirement benefits as early as age 62, but every year you delay receiving them after age 62, the annual benefits increase significantly, until they max out at age 70.
o Spouses may be eligible for Social Security benefits up to half those of their working spouse, even if they have never worked themselves.
o If both spouses worked and paid into FICA, both are eligible for their own “worker” benefits and “spousal” benefits and Social Security will pay whichever benefit is larger.
o Social Security rules are complex and your decision regarding when and how to receive benefits makes a big difference in how large your benefit payments will be. This article focuses on determining a ballpark estimate of your retirement income, not on determining your eligibility or maximizing your benefits.
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