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  • Writer's pictureChris Stein, CFP®

Estimating Your Social Security Benefit

A reader from Kentucky asks if he needs to inflate the PIA estimate given by the Social Security Administration to reflect his estimated benefit at Full Retirement Age accurately.

"I'm trying to understand the benefit estimate the SSA provided to me in my Social Security Statement. I'm 52 years old, and my PIA estimate at FRA (at age 67) is $3,166. (It's $3,950 if delay until age 70). My understanding is that these figures are in current dollars. Do I need to inflate the $3,166 at some assumed growth rate (say 2-3%) for 15 years (from age 52 to 67) to arrive at the estimated amount that I will receive when I'm 67 years old? If this is entirely wrong, could you explain the correct approach? Thanks."

You are correct: those dollar figures are in today's dollars, assuming no inflation. Social Security does a few things intentionally to not mislead people about the value of that Social Security benefit.

They give you the figures in today's terms – not what they will likely be in the future because of inflation, the effects of cost of living increases and wage inflation (indexing your yearly earnings in your earnings record).

That $3,166 is based on a couple of assumptions. First, that you will continue working until your Full Retirement Age (FRA) and earn the same amount as the average of your last couple of years of earnings. Social Security assumes you're not going to quit tomorrow – at 52 – and sit there, not contributing more to your earnings record.

They also assume there will be no further wage inflation. That's not realistic because, unless they cherry-picked a couple of years since the beginning of Social Security, I'm not aware of when there was no wage inflation.

Wage inflation is different from the cost of living adjustment, or COLA, inflation based on the CPI-W. (That's the Consumer Price Index for Urban Wage Earners and Clerical Workers.) Wage inflation has typically been higher than price inflation, and the proof is that our standard of living has increased over the past decades. And that happens when average pay goes up faster than prices. If our pay and prices went up at the same rate, we would never get out ahead. We would still be living at the standard of the 1950s.

But Social Security is assuming that wage inflation is going to be zero. They do that because it suppresses the estimate of your Social Security benefit. That, in turn, will encourage you to save more on your own to embellish what you're going to get.

I know you didn't ask about that, but I wanted to summarize how Social Security is coming up with the benefit estimate – or prediction.

To develop a more realistic estimate of what you receive at your FRA, you would have to determine a reasonable estimate for price inflation over the next 15 years to recognize at least some inflationary pressure. To be even more accurate, you'd have to introduce a realistic wage inflation rate into your earnings record. And you can't just take the $3,166 and increase it by inflation.

Instead, you would need to use a Social Security calculator that lets you adjust the assumption for wage inflation. Also, your extra years of earnings will be entered into your lifetime earnings record, all of which will be affected by future wage inflation – which will likely occur unless something drastic happens in the economy.

The bottom line? The estimate they're giving you assumes you're going to continue to work until you reach FRA. If you don't, then things will completely change. But if you're going to work, the inflationary 'disconnects' in their estimate versus what's likely to be seen in reality have the net effect of lowering your estimated benefit from what it's likely to be.

So, say you're trying to do some retirement planning. You're 52, and you're trying to estimate your cash flows at age 67 and beyond. If you use what they have in today's dollars and apply reasonable inflationary rates to all of your cash flows over the next 15 years to see what your financial picture will look like at 67, that would seem like a reasonable way of doing it.

Of course, Social Security might change its formula in the next 15 years. But the good news for you is that you're getting to the point where the chances of being affected by a change are getting less or less. (I think people under 50 have a greater chance.) But in my mind, once you're over 50 – and you get closer to 62 when you could first file for your Social Security retirement benefit – you are more likely to be grandfathered into any changes that might take place.

We have to admit that there could be a change in the formula. But, if there is none, your actual benefit will likely be higher in real terms than what they are mentioning – that is, the $3,166 and the $3,950.

By the way, your age 70 benefit? An astute person might realize 8% annual delayed retirement credits should make that about 24% higher. It's a little bit more than 24%, and why? Because they're assuming you will continue to work until age 70 – that you will work until you claim, not that you will retire and then simply delay claiming without additional work.

Depending on your earnings record status over time, the extra earning years in your 60s – as you lead up to age 70 – might help your overall average indexed monthly earnings. The effect would be to increase your rate, which looks like what's happening here because you have almost a 25% increase at 70 versus 67. Your delayed retirement credits only explain 24% of that.

Those last comments assume you didn't round any figures. If you are reading the numbers from your statement, $3,950 is 24.76% higher than $3,166.

However, the best thing might be to ignore both COLA and wage inflation adjustments. COLA is just supposed to protect your buying power, not give you any more money. So, to compare apples to apples, if your income source is in today's dollars, estimate the expenses you expect to have in retirement and state them in today's dollars, too. Then figure out how much of those expense items your Social Security will cover. You'll be introducing fewer estimating errors than if you try to use expenses 15 years in the future.

Every approach to projections has its issues or weaknesses. If there were one accurate way, everyone would use it. Whether you're looking at a Social Security benefit or a complete retirement plan – or even just a financial plan – getting one single number right is difficult, especially when you're looking 15, 20 or 30 years out. When we make retirement projections, there are thousands of numbers involved. And, thanks to what's called the Law of Large Numbers, if you look at enough numbers, the trends of those numbers are very accurate.

You might want to compare the trends of your Social Security benefit relative to the trends of your expenses in retirement. And you can do that all with today's numbers. Look at what expenses won't be there when you retire, like making contributions to your retirement or a paid-off mortgage. Remove cash flows that will disappear, and add new ones that might appear. If they total about $3,000, it looks like your Social Security benefit will do a pretty good job of meeting them. But if they are $5,000, the relationship between the two shows a shortfall in secure income to cover your expenses.

That would be my basic approach.

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