Almost everyone has a Social Security number and is eligible for Social Security benefits.
Yet, survey after survey indicates people know little about the program and their benefits. Moreover, much of what people think they know is wrong.
Let’s take a look at some key misunderstandings and oversights about the program.
Understanding Benefit Statements
The Social Security Administration is back to mailing estimated benefit statements to at least some people, after suspending the mailings a few years ago. Estimates also are available online or over the telephone.
But you have to know how to interpret these estimates. They’re likely to be misleading if you don’t understand how they’re computed.
Social Security retirement benefits are based on your highest 35 years of earnings. The younger you are, the more likely the estimate won’t be reliable.
The estimate assumes earnings will increase at the estimated wage inflation rate. Your history of promotions, raises, changing jobs for higher salaries, and being laid off is likely to be very different than the steady path assumed in the estimate.
Some people believe the SSA deliberately understates likely benefits in these estimates to encourage people to save more.
As you age, however, the statements generally should be more accurate, but errors are likely to overstate benefits.
The estimate assumes you work until the age at which benefits begin and that earnings increase at the estimated wage inflation rate.
Many people in their 50s and beyond have periods of unemployment, retire earlier than expected, or take jobs that pay less than their previous positions. In these cases, your 35 highest earnings years could be less than the estimate.
Yet, for some people the estimates still will tend to underestimate benefits. Keep in mind only the 35 highest years of earnings are used. As you work longer, you likely are knocking off low-earnings years from your youth.
Even if you suffer a setback and don’t earn as much the rest of your career as originally anticipated, you could earn more than in the early years.
The online Social Security benefits estimator is more accurate than the mailed estimates. After you register online, the calculator uses your real earnings history.
You also have the flexibility online to estimate benefits using different scenarios. The paper statements mailed to people are limited to a fixed set of assumptions and have a higher margin of error.
Another way to look at Social Security retirement benefits is the replacement ratio instead of the dollar amount of estimated benefits. The replacement ratio is the percentage of your final working year’s earnings the retirement benefits will equal or replace.
The important thing to remember here is that the replacement ratio declines as income is higher. Here are some examples using 2014 data.
For someone who made the minimum wage (about $15,000 annually), retirement benefits on average will be 76.5% of final wages.
For the median income of $33,120, the replacement ratio declines to 58.4% of final income.
Someone whose earnings were the maximum wage for Social Security withholding had a replacement ratio of only 28.2%, and someone earning $165,150 had retirement benefits of only 18.8% of final earnings.
There’s a maximum annual retirement benefit: No matter how much you earn and pay in Social Security taxes, you won’t be paid more in retirement benefits than the year’s maximum.
The last two people in the replacement ratio examples would receive the same dollar amount in retirement benefits, but the replacement ratio declines because the last person had higher final earnings. You can find the latest replacement ratios on the Social Security web site.
Next week, we’ll finish up this discussion. But in the meantime, you’ll find even more little-known, valuable information about Social Security (and every other retirement topic) in my monthly newsletter, Retirement Watch. Click here to learn more.
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