Controversy About Social Security Replacement Rates

I wouldn’t have thought that replacement rates would be a controversial topic, but they’ve become one. Social Security routinely has reported that at median income levels, Social Security retirement benefits replace about 40% of pre-retirement income. The SSA invited criticism, however, when it dropped replacement rates from the latest annual trustees’ report. It turns out that the SSA doesn’t compute replacement rates the way everyone else does, and that led to arguments that the SSA’s previously-published data were misleading. In fact, according to this article, the Social Security replacement rate is much higher for most people than previously reported. This is similar to other arguments that SSA over the years has deliberately mis-estimated the benefits people are likely to receive, presumably to encourage people to save more.

SSA’s headline figures represent the benefits paid to a (supposedly) typical new retiree as a percentage, not of that worker’s pre-retirement earnings, but of the average earning of workers at the time. Table V.C7 of the 2014 Trustees Report, the focus of Munnell and the SSA actuaries’ ire, makes this calculation clear: divide the $19,477 benefit received by a medium earner retiring in 2014 by the $46,787 average wage in 2014 and you get 41.6%, almost precisely equal to the pseudo-replacement rates published by the SSA actuaries.

Unless we live in a world with zero wage growth, the earnings of today’s workers will be higher than the pre-retirement earnings of today’s retirees. Thus, SSA’s measure of replacement rates overstates today’s retirees’ pre-retirement earnings and understates their benefits relative to those earnings. While Munnell and SSA’s actuaries complain about what has been taken out of the Trustees Report, the information that has been added is actually far more revealing.