Yes, I do expect to receive social security benefits when I turn 70 (I will wait until then to maximize the payout as a form of “old age insurance”).  In fact, I think the odds that I will receive some benefit in 2041 (which would be my first payout year) are at least as good as the S&P 500 being worth more than it is today.  However, to feel comfortable relying on social security in my retirement plan, I do need to account for possible cuts to my benefits and adjust for the fact that social security benefits do not keep up with inflation.

Planning for possible (likely?) cuts to social security benefits

A lot of folks are understandably worried about the future of social security.  In 2018 the money paid out to social security recipients is more than the money coming in for social security taxes.  Now, social security has a pretty big savings account that it will tap to make up the difference, so everyone is still getting paid (for now), but the government estimates that those savings will run out in 2034.

So what happens if social security spends all of its savings account and is still paying out more than it is bringing in? Well, a couple of things could happen, including making up the difference from the federal budget, but most seem to expect that benefits would have to be cut. In short, social security benefits would be cut to balance the payouts with the social security taxes collected.

The exact size of that cut is a tough one to estimate, and even the estimates from the social security trustees have moved around a bit, but they have stated that payments to retirees would be reduced by about 21%.  That’s a pretty big cut and, should it come to that, I expect it would not be spread out evenly (though that is just speculation on my part).  Still, when planning my own retirement, I am going to assume that the folks in Washington are underestimating the cut and I will use a higher number, just to be safe.

Personally, I am planning under the assumption that my benefits in 2041 will be 33% less than what they would be under the current formula.  I might get more, but I do feel that is a safe number for me to use when planning my retirement budget.  So, if my estimated benefits under the current formula would be $30,000 a year, I will plan instead to receive only $20,000. [I’ll post a guide to calculating your real social security benefit in an upcoming post, so stay tuned!]

Losing a third of my projected social security benefits is certainly not great, but it is something that I can plan for and take into consideration when I am calculating how much I need to have invested to retire.

I’m not sure if this is good news (social security will be here for me in retirement, yay!) or bad news (social security will be much less of my retirement benefits, boo!), but I’ll look at the glass as half full (or two-thirds full, I suppose).

 

How social security fails to keep up with inflation (and how to be ready for it!)

But if I am going to count on social security, I also need to account for the gap between the cost of living adjustments (COLAs) added to benefits each year and the real rate of inflation.  The social security administration adds a COLA to your payout amount in years where they calculate that inflation merits the addition.  However, to make that calculation they use what’s called the Consumer Price Index for Urban Wage Earners and Clerical Workers, or just CPI-W for short.  The trouble is that the CPI-W measures the increases in the cost of living for working-age and largely urban Americans.  Those folks just don’t face the same expenses in the same ratios as retirees.  Healthcare costs, for example, are a larger part of a retiree’s budget and they have gone up a lot faster than other costs.  Medicare premiums have also been rising fast and are not measured in the CPI-W.

To make matters worse, I think it’s very likely that in the near future the government will change how social security calculates its COLAs to use an even worse measurement, called the Chained Consumer Price Index for All Urban Consumers (or C-CPI-U).  [Seriously, who names these things? Yeah, economists.]  The big difference in the “chained” index is that the formula assumes that people shift to cheaper products as prices go up. In short, it consistently reports even lower inflation numbers, which means changing from the CPI-W to the C-CPI-U will just make the problem worse.  There were serious proposals to make this change in 2015 and 2017 and something like this, I think, is almost certain to happen before I start collecting benefits in 2041.

 

So how do I plan for inflation outpacing my COLAs?

So, the situation we face is that the social security COLA just will not keep up with a retiree’s rising costs of living.  The big question, though, is how can we actually measure that difference and try to plan for it?  Well, I think I have figured that out, at least well enough for me to feel comfortable plugging in some numbers and counting on them.

Happily (and somewhat perversely) the government does have a much more accurate measure of the expenses and inflation rates faced by retirees.  It’s called the Consumer Price Index for the Elderly (CPI-E).  It focuses on expenses faced by folks 62 and older.  Of course, it is not even on the table as an option for social security COLAs because it would raise the payouts more and, hence, deplete social security’s savings even faster.

So what good is the CPI-E?  Well, I gathered up what data I could find from the Bureau of Labor Statistics and compared the inflation rates to see how much of difference the CPI-E would make vs. the CPI-W and the C-CPI-U.  On average, the rate of inflation as measured in the CPI-E is just less than 7% higher than the CPI-W.  When compared to the C-CPI-U, the CPI-E runs almost a full 17% higher.  So, if our social security COLAs were to be based on the C-CPI-U (our worst case scenario), we should expect our expenses to go up by 17% more than our social security COLAs.

For example, let’s say I take my estimated $20,000 per year in social security benefits in year 1.  Then, in year 2 my expenses (as measured by the CPI-E) go up by 3% (which is an average inflation rate). I would need $20,600 per year from social security to stay even.  However, my COLA, if measured by the C-CPI-U, would only be $512, for a total of $20,512.82.  I’m short about $97!  That’s not good, but it probably won’t be the end of the world, since it’s a shortfall of less than 0.5%.

The problem is that the difference expands every year, so by the time I am 5 years in the shortfall is over 2%., at 10 years it’s over 4%, and at 20 years the shortfall is over 8% (at nearly $3,00). The table below shows you the numbers year by year:

Year SS Income Needed SS Income Received Shortfall $ Shortfall %
0 $20,000.00 $20,000.00 $0.00 0
1 $20,600.00 $20,512.82 $87.18 0.42%
2 $21,218.00 $21,038.79 $179.21 0.84%
3 $21,854.54 $21,578.25 $276.29 1.26%
4 $22,510.18 $22,131.53 $378.64 1.68%
5 $23,185.48 $22,699.01 $486.47 2.10%
6 $23,881.05 $23,281.04 $600.01 2.51%
7 $24,597.48 $23,877.99 $719.49 2.93%
8 $25,335.40 $24,490.24 $845.16 3.34%
9 $26,095.46 $25,118.20 $977.27 3.74%
10 $26,878.33 $25,762.25 $1,116.07 4.15%
11 $27,684.68 $26,422.82 $1,261.85 4.56%
12 $28,515.22 $27,100.33 $1,414.89 4.96%
13 $29,370.67 $27,795.21 $1,575.46 5.36%
14 $30,251.79 $28,507.91 $1,743.88 5.76%
15 $31,159.35 $29,238.88 $1,920.47 6.16%
16 $32,094.13 $29,988.60 $2,105.53 6.56%
17 $33,056.95 $30,757.54 $2,299.42 6.96%
18 $34,048.66 $31,546.19 $2,502.47 7.35%
19 $35,070.12 $32,355.07 $2,715.05 7.74%
20 $36,122.22 $33,184.68 $2,937.54 8.13%

 

Even if social security was only half of your retirement income, an 8% shortfall in that half could put quite a squeeze on the discretionary part of your budget.  Losing $3,000 of a $40,000 per year retirement budget is like losing about 4 weeks of income!

This would be a disaster for someone already retired who significantly counted on social security, but since I am not yet retired, it’s just more information to inform my planning.  To be ready for this loss of spending power, I’m just going to take the haircut right off the front end of my social security benefits estimate.

If I was planning for social security to be about a third of my annual retirement income (once I start collecting it).  I would take the 8% shortfall from year 20 and reduce my expected benefits by that much.  So, if I expect to receive $20,000 per year, I take 8% off of that and get $18,400 per year.  With my total retirement income goal of $60,000 per year, I would plan to need $41,600 from other sources (60,000-18,400) instead of $40,000 (60,000-20,000). I can plug that into my retirement plan spreadsheet or use it to adjust the numbers I plug into the Early Retirement Now Safe Withdrawal Rate Toolbox.  Alternatively, I could cut my retirement budget for a slightly more frugal retirement.

In any case, I now feel quite confident relying upon social security as a part of my retirement plan.  All I have to do is assume a one-third cut from what the current payout formula produces and then reduce that by a further 8% (which is about the same as just reducing your current estimated benefits by 40%).  Yes, I might be wrong, but I think there is very little risk of social security being cut any more than by a third and the COLAs being any worse than the C-CPI-U.  I think this is reasonable worst-case scenario planning.  Besides, if it turns out I have a lot more money, then it’s just more fun in the sun or more insurance against rising healthcare costs!

tl;dr:  By my estimates and what I could find in my research, I think the safe bet is to plan to receive social security benefits totaling about 60% of whatever the current payout formula promises.  Odds are I will get more, but this is a number I feel safe planning on.