Are You Over-Reliant on Social Security Income?

  by Shelley Seagler

The Social Security Administration paid out over a trillion dollars in benefits to about 65 million Americans in 2020. Retirees will receive an average of $1,514 per month in benefits that they can use to offset their income requirements in retirement. Of course, an annual salary of $18,168 isn’t enough for most people to comfortably retire, so supplemental income is critical.  

Let’s take a look at how to determine if you’re over-reliant on Social Security income, and if so, how you can reset your expectations.

Will Social Security Be Around?

Many Americans are concerned that Social Security won’t be around when they retire—particularly if they don’t plan on retiring for several decades. While these concerns aren’t entirely unfounded given the state of the program, it’s unlikely that Social Security benefits will disappear anytime soon—and it wouldn’t take much to re-capitalize the program.

The bad news is that the Social Security Administration anticipates that it will exhaust its reserves by 2035. Of course, the COVID-19 pandemic has led to massive job losses that could reduce payroll tax revenue and deplete these reserves even faster. President Trump’s recent payroll tax cuts further exacerbate the problem if they don’t ultimately have to be repaid.

The good news is that ongoing payroll taxes are expected to be enough to indefinitely fund just over three-quarters of scheduled benefits. If politicians chose to raise payroll taxes, they would only need a modest increase from 12.4% to 14.4% in order to maintain full benefit payments through at least the next 75 years—solving the near-term concerns.

How to Right-Size Expectations

Many Americans have unrealistic retirement expectations. For example, the average 64-year-old Baby Boomer has accumulated just 30% of the $1 million in savings that they say they’ll need to fund a comfortable retirement lifestyle and the average 45-year-old Gen Xer has saved just $166,328, according to a Natixis survey of 1,000 American workers.

Social Security benefits can help fill some of these retirement income gaps, but it’s important to have the right expectations when estimating both your income and spending requirements.

Download our Social Security Break-Even Worksheet to determine if you should take Social Security early based on your life expectancy and the expected financial benefit.

Assume the Worst-Case Scenario

Most people saving for retirement should only rely on three-quarters of their expected Social Security benefit. That way, they’re prepared if the Social Security Administration’s reserves are depleted and benefits are cut by about one-quarter. A successful increase in payroll taxes to make up for the difference would be icing on the cake in retirement.

While many people hope to take Social Security at 65 or 70, most people end up opting for early retirement benefits. The most conservative retirement savings strategy is to base projections on your retirement benefits. Health or other circumstances may force you to retire prior to expectations and be stuck at that level of income. Once you reach age 62, you will be in a comfortable position to retire but have the benefit of increased income for each year Social Security is delayed.

It’s equally important to be somewhat conservative when estimating the annual return expectations for a retirement portfolio. While the stock market has historically gained about 10% per year, these past returns are no guarantee of future returns. Most financial advisors recommend using more conservative estimates of four to six percent annual returns.

Accurately Estimate Your Expenses

Setting the right expectations for Social Security benefits is important, but it’s equally important to ensure that you have an accurate picture of retirement expenses. In general, most financial advisors recommend assuming that you will spend between 55% and 80% of what you currently spend in retirement, depending on your income, lifestyle and healthcare costs.

Annual Income Range at Retirement Estimated Retirement Income Replacement Ratio
Less than $50,000 80%
$50,000-80,000 75%
$80,000-120,000 70%
More than $120,000 55% to 65%

Fidelity’s Estimated Retirement Income Replacement Ratios – Source: Fidelity

Some important factors to keep in mind include:

  • Healthcare Costs
  • Mortgage or Rent
  • Income Tax
  • Food & Entertainment
  • Travel

The final step is building up retirement savings in an individual retirement account (IRA) or other retirement program to make up the difference between your anticipated spending in retirement and the Social Security benefits that you anticipate. If you’re over 50 years old, you can make catch-up contributions above and beyond the normal IRA or 401(k) limits.

If you’re already in retirement, you may want to consider ways to boost income. Income investing strategies, such as the Snider Investment Method or dividend investments, can increase portfolio yield while working a part-time job in retirement can help both grow and extend the life of a retirement nest egg.

Maximize Your Social Security Benefit

It’s important to have the right expectations when retirement planning, but there are also several ways to maximize Social Security benefits.

Don’t forget to download our Social Security Break-Even Worksheet to determine if you should take Social Security early based on your life expectancy and the expected financial benefit.

Some of the most popular strategies include:

  1. Try to work at least 35 full years. Social Security benefits are calculated based on your 35 highest-earning years and use an average indexed monthly earnings formula to come up with the amount that you’ll receive at full retirement age.
  2. Maximize your highest earning years. Social Security benefit amounts are based on your earnings, where higher earnings translate to more benefits. Maximizing your peak earning years (typically later in your career) can increase your lifetime benefits.
  3. Delay taking benefits if possible. Delaying Social Security benefits until full retirement age increases returns by 8% per year—and that benefit increases by 8% each year that it is delayed until age 70.
  4. Use spousal benefits to hold you over. Claiming spousal benefits before your own enables you to delay your benefits and let them increase in value. When you reach 70 years old, you can switch to your higher benefits.
  5. Keep your tax bracket in mind. Increasing income during retirement can trigger taxes on your Social Security income. In particular, withdrawals from an IRA can result in an increase in your income tax rate that applies to your benefits as well.

As always, you can speak with a financial advisor to discuss different options and decide on the best plan for your individual circumstances.

The Bottom Line

Social Security plays an important role in most retirement plans, but it shouldn’t be your only source of income. In addition to the real risk of benefit reductions, it’s important to create a realistic budget and save enough in other retirement assets to cover those expenses.

If you’re approaching or in retirement, take our free e-course to learn how stock options can boost your income or inquire about our asset management services.

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